Canadian Director Protection and Small Business: Piercing the Corporate Veil
One of the often discussed benefits of incorporation is ‘limited liability’ that was intended to protect individual directors, officers and shareholders from personal liability, (just for the insurance haters out there – no our industry was not the first to gain such coveted statues….but we did get it in 1862.) While this might have been necessary to promote economic expansion (some would say unwarranted risk taking), it was eventually determined that providing full impunity to any person could actually motivate unwanted behaviour. Therefore, courts and statue had to create avenues for ‘Piercing the corporate veil’ in order to motivate appropriate behaviour. Both terms can be found on Wikipedia, here and here.
Canadian directors and officers can still hold comfort in personal liability protection of incorporation, BUT, there are gaps, and, like any such risk, the exposures need to be identified, quantified, prioritized, mitigated, and, if warranted, transferred. To lift or pierce the corporate veil is to treat the obligation of the corporation as the liability of its shareholders. This can fall under the notion of ‘Joint and Several Liability’ (see ‘Fleischer’ here), but that is a much broader term and corporate veil is more specific to executive personal liability. In legal terms, subjecting a director, officer, manager or shareholder to personal liability does not actually require lifting or piercing the corporate veil. This liability has been created in the Canadian Business Corporations Act, the Ontario Business Corporations Act and other pieces of legislation, but in the insurance and risk management community most of us call any executive liability a piercing of the corporate veil.
Unfortunately, there cannot be a lot of comfort given to Canadian directors and officers, because much of the case law as only been created in the last 10-15 years, it continues to develop, and there are still mixed messages between the Superior and Appeals courts. Shoppers Drug Mart v. 6470360 Canada Inc., here, a 2014 Court of Appeal for Ontario decision, helps confirm the “intersection of corporate and personal liability in the operation and conduct of a corporation”. Keegan Boyd of McCarthy provides a good summary of the case in “Piercing The Corporate Veil May Be Easier Than You Think”, here.
I will not regurgitate the case or the article in detail, but I don’t believe in fear mongering, and this decision should not strike fear in the hearts of the average Canadian corporate director. This was a small Canadian pseudo-professional services company working for a large entity. It had one director and shareholder. It held a ‘clearing account’, like a trust, for the payment of the client’s specific expenses, and an operating account for its own expenses. The client alleged funds were misappropriated as the director transferred too much money into the operating account, leaving the client with unpaid bills, interest and penalties. The motions judge did not allow the piercing of the corporate veil. From par. [41] “The motions judge relied on a decision of the English High Court, Queen’s Bench Division, Creasey v. Breachwood Motors Ltd., [1992] B.C.C. 638 (Q.B.D.), for the proposition that in the absence of a transfer of assets or a fraudulent preference, employees do not assume a corporation’s liabilities.” And in par[42] “The motions judge also relied on Trustor AB v. Smallbone and others (No. 2), [2001] 3 All E.R. 987, at p. at 996 (Ch), a decision of the English High Court, Chancery Division, to conclude that the corporate veil should be pierced not where a corporation has misappropriated funds but where the very use of the corporation is to hide that misappropriation; that is, the company structure is used to avoid or conceal liability for the impropriety.”
The Appeal Court disagreed and said the appropriate case law was Fleischer, where Laskin J.A. stated “that only exceptional cases that result in flagrant injustice warrant going behind the corporate veil. It can be pierced if those in control expressly direct a wrongful act to be done. At para. 68, he stated: Typically, the corporate veil is pierced when the company is incorporated for an illegal, fraudulent or improper purpose. But it can also be pierced if when incorporated “those in control expressly direct a wrongful thing to be done”: Clarkson Co. v. Zhelka at p. 578. Sharpe J. set out a useful statement of the guiding principle in Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co. (1996), 28 O.R. (3d) 423 at pp. 433-34 (Gen. Div.), affd [1997] O.J. No. 3754 (C.A.): “the courts will disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct.”
I wonder if there is a chance for the next court to put this aside based on Pepall JA. ignoring the language “…also be pierced if when incorporated” that Laskin J.A. added to Clarkson Co. v. Zhelka at p. 578. in the second exception? There is not always an intent to direct a wrongful act at the incorporation stage, but if used for such purposes later in its existence the corporate veil would survive.
Insurance Spin and Loss Control:
This is when I usually add the insurance spin. However, it is tough for this specific case. It is not common for one-person shops, even when incorporated, to buy directors’ and offices’ liability insurance (D&O), or meaningful limits on a Crime (Fidelity) policies (a $10,000 Employee Theft sub-limit extension to the Property policy would not cover much of the client’s $2 million dollar loss), or professional liability (aka errors and omission, E&O) insurance. Or even General Liability and Property Insurance. And, there are significant pitfalls for one-person shops within these policies because there are fraud exclusions D&O, E&O and General Liability. While the exceptions to these exclusions in the D&O policy, and, more importantly, a large-limit Crime policy, can be a great source of comfort to innocent directors, officers and managers (and the corporation itself), they won’t have much application when the only allegedly fraudulent party is the only defendant and was also the only person to sign the application for insurance. So my only advice for the one-person shop, 1) buy all of these policies (if you can find a willing insurer(s), 2) don’t misappropriate funds, 3) hope for policy response and that there is no reasonable evidence of fraud against you, and 4) most of the stuff below.
My advice for slightly larger companies, with at least a few directors or managers, 1) buy all of these policies with large limits and deductibles you (not the company, because, especially for Crime and E&O, there may be limited accessible money in the company, but D&O usually applies no deductible to individual insured persons when they are not indemnified by the company) can afford, 2) don’t misappropriate funds, 3) make sure there are good fraud controls in place including multiple signatures on cheques (call and ask me about the J.J. Barnicke case, or find my blog article, here), 4) don’t have all of these exposures covered under the same policy, 5) don’t accept one application form for multiple coverage sections, because you might lose the very important features related to ‘severability’, 6) request multiple signatures, even on forms like Crime that are most often completed by one manager/officer and never vetted by other officers or any director, 7) know that there is no regulation or government/regulator vetting of these policies or the premiums charged, and there are significant differences from one form to another, 8) understand that the real value of your policies are the limits, not the premium paid or the deductible retained; these are smokescreens to hide weak coverage, and trying to save thousands might cost your or your individual directors, officers and employees millions, and, 9) vet your insurance broker and prospective insurers for experience, product knowledge, insurer access, and conflicts of interest.
There is a lot more advice available but it will depend on the nature of your operations and the important details within available coverage.Greg Shields is a D&O, Professional Liability, Employment Practices Liability, Fiduciary Liability and Crime / Fidelity insurance specialist and a Partner at the University and Dundas (Toronto) branch of Mitchell Sandham Insurance Services. He can be reached at gshields@mitchellsandham.com, 416-862-5626, or Skype at risk.first.
CAUTION: This article does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult a registered and truly independent insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decisions. All material is copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this document from any external website must receive the consent of Mitchell Sandham Inc. by sending an e-mail to gshields@mitchellsandham.com.
