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Negligent Execs Can Be On The Hook For Their Company's Failures

Corporations are said to have limited liability. However, that provides less shielding than most people realize.

08/22/2017 15:17 EDT | Updated 08/22/2017 15:17 EDT

A few weeks ago, I wrote about the legal principle of "vicarious liability." That principle makes an employer responsible for damage or harm done to third parties by its employee while on the job, even if the employer personally did nothing wrong.

Sometimes the roles are reversed, such as when a corporation is insolvent. That was observed this week in connection with Sears Canada, which is under CCAA protection (unable to pay its debts, but not yet bankrupt). Sears with its catalogue was once the leader in shop-from-anywhere retailing. Whether its woes are due to competition from newer rivals such as Amazon or poor management is debated.

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A group of creditors, unable to recover from Sears itself, is attempting to sue executives of Sears. The creditors allege negligent misrepresentation, arguing that the executives are personally responsible.

An executive is an employee of the corporation, just like a sales clerk. The difference is that an executive typically had a large salary and has likely accumulated significant personal wealth — enough to make it worth suing that person.

No employee of a corporation is responsible for the debts of a corporation if they are merely debts. However, suppose that it can be proven that an executive misled a supplier, by telling it that the corporation was solvent and would pay for the supplies, when he knew or ought to have known that was false. The executive may be financially responsible for the loss to the supplier.

Corporations are said to have limited liability. However, that provides less shielding than most people realize. It means that you cannot be sued for the debts of a corporation just because you are its share owner. However, if you are a corporate owner, director or executive who personally causes the corporation to do something negligent, there may be no protection.

This is sometimes referred to as removing "the corporate veil." Dorothy lifts the curtain, revealing the human being behind the Great Oz. If the corporation is insolvent, and the people behind it committed legal wrongs such as misrepresentation, it is fair game to go after them for it.

Merely going into debt, with the honest intention of repaying it but finding yourself unable to do so, is not a legal wrong. Something beyond this must be proven to create personal liability.

Given the murky internal workings of a large corporation, it is often difficult to identify who was actually responsible.

Corporations are legal fictions, without hearts or minds (at least until they start to be run by AI computers). Everything that a corporation does is by the act of a real human being who made a decision. If it was a malicious or negligent decision that caused harm to somebody else, that person is liable for the damage caused. There is individual responsibility where evidence can be found that a particular individual was responsible for the fateful decision.

Given the murky internal workings of a large corporation, it is often difficult to identify who was actually responsible. That makes it challenging to get the evidence to assign blame. Sometimes large corporations will deliberately settle and give in to doubtful claims, in order to avoid investigations that might identify individual executives who could be blamed.

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It is riskier to be the executive of a small business corporation, where there are fewer players and it is easier for plaintiffs to prove who was at fault. To take an example, if you incorporate your small restaurant, and somebody falls down the stairs going to the washroom — you are personally liable for the injury if you designed those stairs in a negligent manner. If the corporation has no insurance or assets, or not enough to cover the damages, the injured person may seize your personal property, such as your car, personal bank account or house. Incorporation provides you with no protection against this type of liability if it can be shown that your personal mistake caused the injury.

The burden is particularly onerous when it comes to taxes such as HST and CPP that companies collect on behalf of the government. The tax statutes have been written so that the burden of proof is reversed. Unlike the situation of private plaintiffs, the government does not have to prove that the director was negligent. Merely being a director makes you personally liable unless you can prove that you were diligent in ensuring the company was remitting taxes.

If you are the director of a corporation, merely walking away and having nothing further to do with it is not enough.

It often happens in small business corporations that friends or non-participating family members are signed on as directors, sometimes even without their knowledge. If you are a director, you are legally responsible to the government under the Excise Tax Act, even if you had no clue about what the corporation was doing. The CRA can be relentless in going after people who owe taxes, and does not accept ignorance as an excuse. People often argue that they had a passive role or did not even know they were directors. In one recent case, the judge accepted that a woman had no active role in her common-law spouse's company, of which she was a director, and that he had misled her about its business. She was nevertheless found liable for more than $130,000 of GST that the company had failed to remit.

If you are the director of a corporation, merely walking away and having nothing further to do with it is not enough. You should take formal steps to legally resign as a director in order to get free of responsibility. On the other hand, even formally resigning may not be enough if you continue to run the business and behave as if you were a director. As too often happens, it is small business people that get caught in these traps for the unwary.

Peter Spiro is a Toronto lawyer practicing civil litigation with the Friedman Law Firm. The legal information in this article is of a general nature, and should not be considered legal advice to the reader.

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