Insolvency or Bankruptcy within a Limited Company
I was wondering what would happen if a limited company were to file for bankruptcy? What is Director Liability? Would the owner be held responsible for anything personally if say the company and all it’s assets are worth $40K and their debt is $60K.
The answer to your question depends on the nature of the assets you have, if they have been pledged as security to secure one or more of the corporate debts, and any personal guarantees that may have been signed by the directors/shareholders of the corporation.
Limited Company – “Person” under the Law
A limited company is considered a “person” under Canadian law. As such, it is complete with its own legal right to do such things as enter into contracts, is subject to taxes, own assets etc. A company then legally owns assets, is responsible for debts or liabilities that it incurred in its operations. If, over time, the company incurs more debts that it can deal with and is unable to pay, it may then be insolvent if it unable to meet its financial obligations as they become due.
If the limited company has assets that it owns, those assets must be used (i.e. sold) to pay off the company’s debts. In some cases where the company is small, there really is no value in the assets remaining, the company just stops operating or closes down. In these cases as there are no assets available for creditors, if the company stops operating, it may be that individual/person running the company may be personally responsible to pay off the company’s debts. But it depends on the types of debts. This may mean that Directors/Shareholders may have to use some their own potential assets (i.e. cash) to pay the debts of the company.
Limited Liability for Directors
The concept of a Limited Liability company was designed to limit the liability of the company’s Directors and Shareholders. In this way, if the company found itself to be insolvent, that creditors could not “pierce the corporate veil” and financially go after the Shareholders or Directors. Thus, if there are no assets remaining in the company, then creditors have no one to collect from other than the company’s assets. This does not address Directors Liability
Director – Personal Guarantee
So, how do creditors protect themselves to make sure they will get paid? They quite often will require a “personal guarantee” from either the Directors of the limited corporation before offering credit. Further, Directors/shareholders often use the own credit cards or lines of credit to float the business. Use of personal credit sources will mean you are personally responsible for the “company debt” .
Directors of a limited corporation also owe Directors’ Liability which is an automatic obligation for certain types of debt. For instance, in British Columbia a Director of a limited corporation can be held personally responsible for unremitted source deductions from employees, unpaid employee wages, GST/HST, PST etc. The list is varied and it is dependent on the individual circumstances.
Small Business Debt Options – Proposal to Creditors
If the company has a viable business but is burdened with too much debt, then the Directors may want to consider filing a Proposal to Creditors. A Proposal allows the company to continue to operate and pay back a portion of the debts on a go forward basis. This is a negotiated settlement with creditors and is always different in each circumstance. The best thing is that a Proposal will always give more back to the creditors than they would get in a bankruptcy and may allow the company to continue.
In a bankruptcy, the company does not continue to operate but rather its assets/business processes are sold off with any net proceeds being divided up among the creditors.
Even in a bankruptcy however, any creditor that had a personal guarantee against one or more Director, could continue to collect against the directors/shareholders where applicable.
Winding Down a Small Business
If in your case the assets are “free from any secured charge”, then you can go about selling them and paying off the debts yourself. Or you may seek the assistance of a bankruptcy trustee. If you proceed on you own, you must make sure that all of your creditors are treated “fairly”/equally. This idea of “equally” is where trustees in bankruptcy or licensed insolvency trustee may be best used. All LIT’s are governed under federal statute, the Bankruptcy and Insolvency Act, which outlines what a “fair” process looks like and who if anyone can leapfrog to the front of the pack. Having a trustee involved ensures that fair logical process is taken and can save you, as Director, from claims of unfair distribution of assets.
If the company assets are subject to a secured charge from a bank or a lien from the Canadian Revenue Agency, then those creditors may take steps to ensure that they are the only ones who benefit from any sale and distribution of company assets. Sometimes squabbles occur as to who if anyone has a secured charge on the assets. This once again is when you would need the assistance of a bankruptcy trustee (LIT) whose job it is to sort out all of these types of issues.
Other related topics on Limited Company Bankruptcy or Insolvency
We offer a free consultation if you would like to discuss these options further.
Colleen Craig, CA, CIRP
C.E. Craig & Associates Inc.
204-2736 Quadra Street
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