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The purpose of any bankruptcy, whether it is business or personal, is to liquidate one’s assets and redistribute that value among your creditors. However, there are additional considerations pertaining to corporate bankruptcies and business debts, in particular. This blog will focus on these aspects.Let’s Talk
Sole proprietor bankruptcy
For a sole proprietor, the bankruptcy process will be identical to personal bankruptcy. This is because legally, a sole proprietorship business is not separate from the individual running that business. By comparison with an income tax return, a sole proprietor won’t file a separate return with Canada Revenue Agency (“CRA”) to declare business income. Instead, business income will be reported in a single personal T1 income tax return. Having said that, upon filing for bankruptcy, a sole proprietorship business might require a new business number from the CRA. For more clarity, despite the bankruptcy of the sole proprietor, the business operations may continue.
In the case of a partnership, it can continue to operate even if one partner files for personal bankruptcy. If the partnership only had two partners then upon personal bankruptcy of one of the partners, the partnership can no longer exist. It is possible to assign the entire partnership into bankruptcy as well. Currently, there are conflicting rulings on the issue of whether or not partnership bankruptcy should compel the individual bankruptcies of the partners. A Licensed Insolvency Trustee (“LIT”) would be able to review and provide tailored advice in each case.
Incorporated business bankruptcy
The moment a business is incorporated it becomes a separate legal entity. To assign a corporation into bankruptcy, the board of directors will have to hold a meeting and pass a resolution permitting the assignment. One of the directors (or sole director) will be required to execute corporate bankruptcy papers. Upon bankruptcy assignment, the LIT will notify business creditors of the bankruptcy proceeding, hold a meeting of creditors, conduct a sale of assets and carry out its other duties in accordance with the Bankruptcy and Insolvency Act.
Just like corporate assets are not personal property, personal assets of an individual are not the property of the corporation. Accordingly, the personal assets of the shareholders, directors, and officers of the business do not get affected by the business bankruptcy and will not vest with a bankruptcy estate of the corporation.
Although in some cases the LIT might continue business operations for a short period of time to enhance the realizable value of the business assets, generally speaking entering a corporate bankruptcy means that the normal business activity will cease.
Most business bankruptcies will be filed voluntarily. However, a creditor may petition the business into bankruptcy through the court.
Unlike personal, in corporate bankruptcy, no asset or income can be exempt from seizure and no discharge will be given to the company unless all claims are paid in full.
Extra attention should be given to the matters of corporate liabilities which are often twofold. Despite a corporate veil, it is not uncommon that the downfall of the corporate business will also mean personal financial troubles for the business owners. Let’s explore the most notable categories of such issues.
Business contracts and agreements including loans
Whether you are leasing business premises or equipment or obtaining a bank loan or entering into a contract with a major supplier, these parties may and often do, ask for a person to personally guarantee the company’s agreement, indemnify the creditor or be a co-borrower/co-lessee under the business contract. The common denominator in all these instruments is that the individual becomes personally liable for the debts of the business. In these instances, if the creditors are unable to collect the debt from the business they have the right to pursue collections from the individual. You should always read every document before signing it to understand its terms and conditions and whether or not you are signing it on behalf of the corporation or in your personal capacity or both. Seeking the advice of a legal counsel before executing any agreement/contract is always a good business practice.
If you did not keep a copy of the contract and are unsure of your liability exposure, you may always ask the creditor for a copy of the document.
HST and payroll taxes
Another large category of business debt where a person might end up being personally liable is HST and payroll taxes. If CRA is unable to collect these taxes from the business, CRA has a very effective procedure enabling them to personally assess a director of the business to become liable for the full amount of these taxes. There are generally referred to as Directors Liabilities
In case of unpaid employees’ wages, corporate director(s) may be liable for up to $2,000 per employee plus another $1,000 in case of a traveling salesperson if the amounts have been owed in the last 6 months.
Business malpractice, alleged wrongdoing, and negligence of the business owners
The creditors of a small company tend to associate the owner of the corporation with someone personally responsible just for anything that goes wrong with the business. As a result, some creditors start lawsuits against the business owners in addition to suing the corporation itself. Even if the case has no merits but the individual does not defend the action, the creditor will be successful in obtaining a court order (judgment) against that person. Redirecting business mail and keeping potential creditors upraised of your whereabouts will ensure that you won’t miss any important correspondence and have an opportunity to timely address any pending issues and lawsuits.
There are various types of insurance policies that can be purchased that are designed to protect against these claims.
CRA debt and transfer of assets
Under section 160 of Canada’s Income Tax Act, if a transferee receives property from a tax debtor (transferor), the transferee may inherit the transferor’s tax liability. The section is applicable to individuals as well as businesses. Two noteworthy details about this section. One is that it does not matter whether or not the transferee had the intention to deprive CRA of the tax collection remedies, and the second is that there is no limitation period for an assessment under section 160. Furthermore, section 160 applies regardless of the recipient’s knowledge of the original taxpayer’s tax debts.
Section 160 is triggered when anything of value is transferred for less than fair market value to a person not dealing at arm’s length including an individual under 18 years of age.
Once the assessment is raised, the transferee will have an opportunity to object to the assessment. Each section 160 assessment is unique as it is based on specific facts. There are known cases where even mortgage payments were considered a “transfer” by the CRA. Therefore, it is highly recommended to consult a tax professional before considering a response to section 160 assessments.
Declaring corporate dividends is another example of a transfer of property. Corporate shareholders may get a personal liability for corporate income tax in cases where dividends were declared by the corporation while corporate tax remained unpaid. It is within the purview of a corporate accountant to look out for this issue as well as prevent it and advise business stakeholders accordingly.
A bankruptcy of the tax debtor will not cancel section 160 assessment of the recipient of the property.
It must also be noted that corporate bankruptcy cannot shield individuals from the personal obligations arising out of the circumstances reviewed in this blog. However, the amounts owing by the individuals might get reduced by the payments made out of the corporate bankruptcy towards the same debts. These payments, though, will depend on the amount realized from the sale of the assets, if any, the type of the assets, and the priority ranking applicable to the creditors’ claims.
Speak to a Licensed Insolvency Trustee
If you found yourself personally liable for any of the “business” debts, the creditors will be able to exercise the usual range of their collection and enforcement powers including legal proceedings, garnishing wages, writs, liens, garnishing tax refunds, seizure of bank accounts and other assets. If you are unable to pay your debts in full, you might need to consider personal bankruptcy or a proposal. The bankruptcy or proposal will immediately stay creditor’s collections and enforcement measures.
Yet, a business bankruptcy is an important step in allowing an orderly liquidation process to occur which would have positive outcomes for both business owners and the creditors. It would ensure transparency, eliminate uncertainty and create clear communication channels which, in turn, might help to mitigate the risks of the lawsuits against the business owners as well as to take a lot of additional pressure away from them.Let’s Talk