Dear founder: Your company is not a magical force field
Like many of your fellow entrepreneurs, you received the fantastic advice to incorporate your business early. You were told that operating through a company would help you in a number of ways, from accounting to tax to legal. Indeed, incorporation is an important business tool, creating an entity that is a separate legal person to enter into contracts, take on obligations, and bear risk. This liability shield gives certainty that innovators and investors need not risk their entire personal net worth to pursue a potentially lucrative business opportunity. From that perspective, incorporation was a valuable step in managing the risks of your entering the business world, and certainly advisable.
But you must remember that the corporation is not—and will never be—an absolute protection, giving you license to act with abandon as if there is a force field protecting against all liability. As you hurl towards your business goals atop your trusted corporate vehicle, think of corporate protection more like an airbag or a helmet, rather than some magical shield against all personal damage: you’re safer, but you’re not invulnerable.
You can only wear so many hats
As a founder you often wear many hats in your company, particularly at an early stage: you may be the CEO, chair of the Board of Directors (or even the sole director), the largest shareholder, and hopefully you’re employee of the month (or, if not, it’s because you’ve hired someone brilliant to do great work for you). But with each of those hats comes separate roles and responsibilities, and yes, even potential liabilities.
When your company was incorporated, you made it harder, but not impossible, to be personally liable for risks associated with the company. As a director of that company, for example, you may have personal liability under many statutes, including for directing misconduct, failing to pay wages, for directing breaches of our anti-spam laws, for some tax obligations, and many more. You can also still be held accountable for any criminal actions or offenses that you or your company may commit.
Piercing the corporate veil
Even in your role as a founding shareholder, Canadian (and US) law permits personal liability for corporate activity through what courts call “piercing the corporate veil”, where a court may look past the immediate corporate entity into the ownership structure to properly assign liability. Courts are understandably very reluctant to do this, given the importance of the role of the corporation in society. However, where a corporation is used simply as a cloak, a shell, or an alias for an individual operating in business, and where it is in the public interest to do so, they will absolutely do so. For example, where crimes are being committed, or where the company’s conduct is akin to fraud (though no actual fraud is required), it may be necessary in the interests of justice to look past the corporate form to the individual.
Treating corporate assets as your own, failing to commit to proper corporate governance, and leaving gaps in recordkeeping can provide ammunition to those seeking to pierce the corporate veil, and will at least allow a court to consider doing so. And no, while you might think that setting up multiple companies means having multiple layers of protection, this, too, is not infallible. Courts have shown even more of a willingness to look past a corporate entity where a parent company is being shielded by a shell, considering how the company treats profits, who makes the decisions, and where ultimate control lies. Collapsing a corporate chain that appears to have been set up for the sole purpose of limiting liability, and where there is no real separation of governance between parent and subsidiary, is often seen as less controversial than passing liability through to individual shareholders.
So, you should always think about the clear delineation between your personal affairs and those of your entity. First, think carefully about who owns the accounts, properties and assets that the corporation uses to carry on business. If you do personally own assets used in the business, you should make sure to document that relationship (and think about whether you should own them or transfer them to the company). If you want to transfer them, you should get tax and legal advice on how to properly and efficiently convey the assets. By structuring business-related assets and relationships properly in the name of the company, you make it easier (should someone want to pursue you personally) to argue that they have come after the wrong person (i.e., you vs. the company, which is also referred to as a “person”). Imagine a person who owns all of their own carnival equipment but incorporates a company to sell ride tickets: it’s not a far stretch to imagine a court assigning some liability to owner of the equipment if something should go wrong.
Good corporate governance matters
Not only should your relationship with your company be well-papered, including with written contracts if you choose to lend money to it (or if it advances you funds), but you should also make sure to have clear corporate governance: things like holding shareholder meetings (even if just with yourself on paper!), keeping good records (including meeting minutes, fully signed and completed contracts, and accounting), and hiring external experts like lawyers and accountants to provide impartial third party advice on key issues.
Remember, a key factor for courts in considering whether to “pierce the corporate veil” is whether the corporation is simply a formality that is dominated by an individual, and evidence that the corporation operates professionally and upholds its statutory obligations in corporate governance is key to shielding personal assets.
Understand and act within the legal regimes you are subject to
As a final tip, which should go without saying but must be stated nonetheless: a corporation doesn’t give you permission to break or ignore the law. The vast majority of cases where courts have opted to pierce the corporate veil and find individuals liable have been in situations where there has been conduct akin to crime, fraud or wilful misconduct. When something truly bad happens, the courts want to, and will, find someone responsible. Courts are not eager to hold individual founders liable for the legitimate business operations of a corporation with its own assets, governance, and paper trail, trying to do the right thing and follow the right laws. But if you don’t take those basic steps, you are providing them with a very good reason to consider looking past the corporate form to the individuals behind it.
It is also worth noting that certain laws apply extraterritorially, meaning that even if you commit a criminal offense outside of your country's borders, you can still be held accountable for that offense under the laws of your home country (whether performed on behalf of the company or not). While it sounds rote, we would here point out that it is essential to be aware of the potential consequences of your actions, both domestically and abroad, and to always conduct yourself in a manner that is consistent with the law.
Why does all of this matter?
A counterparty (whether it’s an aggrieved customer, a competitor, or regulator, or the state itself via criminal action) does not need to be correct about your personal liability in order to name you personally in a lawsuit against your company. That’s for the court process to determine and this question can be a set of proceedings in and of itself. Of course, a litigant may never successfully convince a court that your company wronged them, let alone to pierce the corporate veil, in order to find you personally liable for a wrong committed in the name of company by you. But it is expensive to defend yourself even if such a claim is unwarranted or unsuccessful, and the long litigation or enforcement process can be a deep pit into which many an entrepreneur’s time, money, resources, effort and energy can be cast.
As lawyers, we are sometimes asked to advise on how to keep from getting sued. But the reality is, nobody can prevent you from getting sued. The best you can do is to follow proper governance, understand and act within the legal regimes you are subject to, and document your operations well, so that if and when a lawsuit or regulatory action does come your way, you have already laid the groundwork for an easy defense. And if they come after you personally, it’s nice to be able to point to a well-maintained, purposeful corporation in order to say, “wrong person.”