Urban Myths About the Corporate Veil
Commonly Held Beliefs About Personal Liability Protection After Incorporation
Page last modified : December 05 2023
For a better understanding of limited liability protection, a corporate veil has been revealed. Scott McEachern wrote this.
Let me begin this essay with some background information. Generally, I hear from small business owners who began out as sole proprietors and then, somewhere along the way, a lawyer, accountant, insurance broker, or financial planner persuaded the small business owner to become a corporation.
To incorporate for tax benefits and/or personal liability protection from a ‘corporate veil’. So the small business owner incorporates, but then takes the basic information regarding personal liability protection acquired too literally and settles into a nice and fuzzy cozy blanket known as a false sense of security.
What’s more, the small business owner probably paid the hundreds-of-dollars-per-hour-lawyer handling the incorporation for information about corporate law concerns like articles of incorporation, bylaws, quorum, issued shares, taxation, and so on, while only briefly mentioning the benefits and limitations of limited personal liability. Sadly, the term “limited” enters one ear and leaves the other. After all, we all know that incorporation now means the business’s owner-director cannot be sued, right? WRONG.
The restricted personal liability benefit for the owner-director of an incorporation, as explained by a corporate law professional, relates to protection against liability for a breach of contract by the corporation or tortious acts by persons hired by the corporation, such as workers or subcontractors. Quite
1st Sidebar:
Please keep in mind that as a paralegal, the Law Society of Ontario’s governing rules state that I cannot provide corporate law services but can advise on tort law matters involving corporations – this article is about tort law personal liability risks that owner-directors of small contracting corporations face, often unknowingly.
2nd Sidebar:
A tort is a legal infraction that, other than breach of contract, is punishable by monetary damages or other relief. General carelessness, negligent workmanship, negligent supervision, misrepresentation, misstatement, deception, and so forth are examples.
The fallacy that incorporation protects the director and officer owner of a corporation is multidimensional and stems from significant practical disparities between large corporations and small business corporations. The rules are the same for both, but the actuality differs between the large and the little. The owners of major firms are frequently millions of faceless stockholders. A large corporation’s decisions are decided by the board of directors and officers, as well as a management team (the “executives”) who are primarily acting on behalf of the shareholders, and the executives are frequently substantial shareholders themselves. These executives make a variety of judgments and act in a variety of ways that may expose them to liability concerns; yet, these executives wrongdoing.
The owner-director of a small firm, on the other hand, will frequently leave the boardroom and get their hands dirty in day-to-day operations. By doing so, the small corporation owner-director exposes himself to a wide range of tort liability risks, threatening bank accounts, investments, and the virtually paid-off home; ADGA Systems International Ltd. v. Valcom Ltd., 1999 CanLII 1527.
As previously stated, the hands-on small corporation owner-director may be held accountable for tortious wrongdoings in which the owner-director plays a role. This was confirmed recently in the case of Khursheed v. Venedig Capital SAS, 2019 ONSC 5190, when it was stated:
[26] Case law establishes that, unless there is a separate cause of action against them, officials, directors, and employees are immune from personal liability for conduct performed under a corporate name. In ScotiaMcLeod Inc. v. People’s Jewellers Ltd. (1995), 1995 CanLII 1301 (ON CA), 26 O.R. (3d) 481 (C.A.), at pp. 490-491, the Court of Appeal stated:
The examples in which workers and officers of corporations have been found personally liable for conduct apparently carried out in the name of a corporation are fact-specific. They are also uncommon in the absence of findings of fraud, deception, dishonesty, or lack of authority on the part of employees or officers. … However, in each case, the facts giving rise to personal culpability were expressly asserted. Absent allegations that fall into one of the categories described above, officers or employees of limited companies are immune from personal liability unless it can be demonstrated that their actions are tortious in and of themselves or that they have a separate identity or interest from the company such that the act or conduct complained of is their own.
[27] The Court of Appeal went on to say that because a corporation may only exist through human agents, its directors or officers may induce it to sign a contract. This does not, however, imply that “if the actions of the directing minds are found wanting, that personal liability will flow through the corporation to those who caused it to act as it did”: Scotia McLeod v. People’s Jewellers, at p. 491.
[28] Subject to the exception for liability for procuring a breach of contract, directors and officers are liable for their tortious behavior even if it was oriented in good faith to the best interests of the firm.Valcom Ltd. v. Adga Systems International Ltd. (1999), 1999 CanLII 1527 (ON CA), 43 O.R. (3d) 101 (C.A.), at para. 18. A distinct claim must be presented against the people in their personal capacity in order to properly plead a cause of action against the directors or executives of a corporation:People’s Jewellers v. Scotia McLeod, p. 491. The statement of claim must allege tortious actions taken by the individuals or demonstrate a different identity or interest from that of the individuals.
Because the small corporation owner-director is frequently hands-on, he or she is almost certainly somewhat directly involved if an incident involving general negligence, negligent hiring, negligent design, negligent craftsmanship, negligent supervision, misrepresentation, or misstatement happens. Stakeholders such as client property owners, neighbors, employees, subcontractors, material suppliers, equipment operators, banks, governments, the general public, and others whose well-being may be harmed or injured by a small corporation owner-director’s hands-on wrongdoing (whether intentional or unintentional) can and frequently do sue.
Courts have ruled that “where those actions are themselves tortious or exhibit identity or interest from that of the corporation so as to make the act or conduct complained of their own, they may well attract personal liability.”; Blacklaws v. Morrow, 2000 ABCA 175 at 41.”… the Court of Appeal in AGDA Systems confirms that a breach of a duty of care owed by a director to a plaintiff can result in separate tortious liability”; Pelliccione v. John F. Hughes Contracting and Development Company, 2005 CanLII 24822.
So, what can the small corporation owner-director do? Well, firstly avoid being naive. Secondly, proactively manage your liability risks by:
- Speaking to a corporate law lawyer that also deeply understands tort law and civil litigation matters to learn more about how limited the limited personal liability benefits are when having your business incorporated;
- Speaking to your financial planner for hints and tips on protecting your assets;
- Speaking to your insurance broker about general liability insurance, directors' & officers' liability insurance and other insurances; and
- Speaking to your trade association, advisors, consultants, educators, friendly competitors, and others for the purpose of learning, and using, risk management hints and tips that help to reduce the possibility of accidents and general business wrongdoing.
An exception to the common rule that a director of a corporation can be held accountable when personally participating in a tortious act is when the director, as the corporation’s directing mind, makes decisions relating to contract breaches. While unlawful wrongdoing in tort law generally includes the wrong of inducing breach of contract or interfering with contractual relations, Lumley v. Gye, (1853) 118 E.R. 749, there is an exception when a director makes such a decision within the scope of the director’s duties, and legal claims should not be brought in these situations. As a result, if the director-owner of a small business corporation ‘decides’ that the corporation is not paying certain invoices for products purchased by, or services given to, the corporation, the corporation is not paying those bills.
Additionally, sometimes a small business owner will fail to engage with the public or clients in a manner that clearly shows that the owner is engaging on behalf of the corporation. Where the owner fails to clearly identify the corporation to the public or clients, the owner is unable to hide beneath the corporate veil as the law will treat the owner as a personally liable sole-proprietor.
Lastly, I want to share with you the flip side – what if we were wronged by the owners, managers, or employees, of a small corporation while said were acting on behalf of a corporation – who can be sued?
The answer is the small corporation entity (i.e. ABC Contracting Inc. – “ABC”) and all those persons tortiously connected to the wrong. As a very simple example, if employee ‘Bob’ of ABC negligently digs a hole resulting in a ‘trip and fall’ injury after being hired by ‘Joe’, trained by ‘Jim’, and supervised by ‘John’, a case may be made out for suing ABC corporately as well as Bob, Joe, Jim, and John personally. Of course, the practicality of who to sue in a given situation needs specific circumstances evaluation by a legal professional. If the injuries are relatively minor, a licensed paralegal can help assess the situation and potentially bring legal action in the Small Claims Court; however, if the injuries are serious, a lawyer’s attention is required.