Are you personally liable for your business debts? The answer may surprise you
Incorporating a business offers several benefits, including lower taxes on company income and limited liability for the company’s founders and shareholders. The latter is one that’s often misunderstood by entrepreneurs.
Many business owners assume that setting up their company’s legal structure as a corporation automatically protects their personal assets against potential claims by creditors or litigators. Unfortunately, some owners have learned the hard way that this protection doesn’t apply in all cases.
Here are some factors that can erode the legal safeguards offered by a corporate structure:
- Personal guarantees: It’s not unusual for banks and other creditors to ask for a personal guarantee from a business owner or even from a spouse who isn’t involved in the company. Landlords and some suppliers have also been known to insist on a personal guarantee as a condition to doing business.
Too often, business owners don’t think twice about using their personal assets to back a bank loan, line of credit, rental agreement, or supplier contract. Some sign because they don’t fully understand the consequences, while others don’t even realize they’re providing a personal guarantee—because it’s buried somewhere in the fine print of a contract.
- The company credit card: Banks will often offer small business owners a company credit card, which provides the convenience of keeping business expenses separate from personal shopping. But in most cases, these company credit cards are tied to the business owner’s personal credit—the result of a consumer credit application filed under the business owner’s name or a personal guarantee clause included in the credit card agreement.
The bottom line with these credit cards: even when they’re used solely to make purchases for an incorporated company, failure to keep up with payments will affect the business owner’s personal credit record and put personal assets at risk.
- Your role as director: A corporation’s directors are personally liable for any wages and vacation pay owing to employees, as well as HST and payroll deductions such as employment insurance premiums and Canada Pension Plan employer contributions. This means creditors, including the Canada Revenue Agency, can go after the personal assets of business owners and any family members who sit on their company’s board of directors.
Some entrepreneurs address this risk by giving up their director’s seat. What they may not realize is that they’ll continue to bear responsibility for any liabilities incurred during the time they served on the board of directors.
What you can do to minimize your personal liability
It’s a good idea to talk to a professional with expertise in contracts or financing before you sign on the dotted line. This person can help ensure you understand all the fine print in a loan, rental or supplier agreement, and identify buried clauses such as a personal guarantee.
The right professional may also be able to help you negotiate an agreement without a personal guarantee or reduce your family’s liability by removing a personal guarantee requirement for a spouse or family member who isn’t part of the business. Did you know that if only one spouse provides a personal guarantee, the other spouse’s assets—including his or her share of the equity in the family home—cannot be seized by creditors?
For more information, here is an article that explains how businesses can protect themselves from creditors, legal action and other situations.
When things go wrong: What you don’t know can hurt you
If your business is struggling and you’re worried your creditors will go after your personal assets, the first thing you need to do is find out what is and isn’t protected under Canada’s business incorporation laws. Federal and provincial government websites can provide some helpful information but tend to be general in scope. In fact, the fragments of information you pick up here and there may do more harm than good because they likely won’t add up to complete and accurate intelligence.
To get a good grasp of your particular situation and the options available to you and your business, it’s best to consult a lawyer, tax account or licensed insolvency trustee who can review your contracts with your creditors, landlord, and other parties. Based on this review, your qualified professional should be able to advice you on next steps, such as refinancing, filing a proposal or bankruptcy.
Sound decisions begin with the right information
Making sound decisions for your business requires a solid understanding of all relevant information—including your personal liabilities for business-related debts and obligations. By arming yourself with this knowledge, you’ll be better prepared to deal with financial challenges today and in the future, while reducing the risk to your family and personal assets.