Entrepreneurs often hear that one of the first things they should do is incorporate, in order to protect their personal assets from potential liability. A corporation is an artificial legal person with a separate legal personality, existence and its own rights, duties, assets and liabilities that are distinct from those of the individuals who collectively own the shares of the corporation.  The owner of a corporation will not be seen to be engaging in a particular business merely because a corporation of which he or she is an owner is engaged in that business. However, it is important to note that while those personal assets are generally sheltered from the corporation's liability, they are not always and completely out of reach.

In certain circumstances, the courts will disregard the separate personality of a corporation and deal instead with the economic interests lying behind the legal façade of the company, with the potential result of finding the shareholders, directors or other persons in effective control of the corporation, personally liable for the corporation's obligations. This is known as "piercing or lifting the corporate veil". It is important to note at the outset that the courts are generally unwilling to pierce the corporate veil. The policy rationale is that the constant recognition of a corporate personality promotes stability as otherwise investors and business people would be unable to predict when the corporate form would be respected.  It appears that the courts will pierce the corporate veil only where required by statute or where extraordinary circumstances exist.

Legislation has provided express authority for piercing the corporate veil. For example, Business Corporations Act (Ontario) provides that upon a dissolution of a corporation, shareholders to whom any of the corporation's property was distributed may be liable to satisfy a pre-dissolution judgment against the corporation. If a corporation commits an offence under the Workplace Safety and Insurance Act, every director or officer of the corporation who knowingly authorized, permitted or acquiesced in the commission of the offence is guilty of that offence, whether or not the corporation has been prosecuted or convicted. Under the Income Tax Act, it is important to note that directors are jointly and severally liable to Canada Revenue Agency for employee source deductions for Canada Pension Plan and Employment Insurance premiums as well as G.S.T. which the corporation has failed to remit.

The veil of incorporation cannot be used for the purposes of fraud, dishonesty or the avoidance of a legal obligation. For example, courts have lifted the corporate veil and found a sole shareholder personally liable, where funds were transferred from one corporation to another in an attempt to make the first corporation judgment proof. Short of fraudulent or dishonest behaviour, simply taking advantage of the limited liability of a corporation per se is not improper. 

For limited liability to apply, the company must act for itself and not as an agent of the shareholder. Clear evidence of agency will be required to defeat the presumption that the company is acting on its own behalf. A contract made by a corporation will not be imputed back to the owner of the corporation on an agency basis unless it can be shown that both parties so intended at the time of the formation of the contract. If the company never carries on business, but it continues to be conducted by the shareholder personally, then the shareholder will be responsible for the debts, obligations and liabilities arising from the business. In other words, to retain its separate legal personality and keep the corporate veil intact, the corporation cannot be used solely as front for essentially acts and operations of the principal shareholder.

Details matter! If a corporation is to retain a separate personality, it must act as a separate entity and be treated as such by those with effective control of the corporation. While it is obvious that a corporation which has not been validly incorporated and organized cannot carry on business, even if properly incorporated, the degree of observance of corporate formalities such as maintaining the corporate minute books and records is very important. The distinction between the assets and liabilities of the corporation and those of its shareholder must be clearly marked, observed and maintained. A shareholder will not enjoy limited liability where he or she enters into a specific transaction in his or her personal capacity. As a result, the manner of execution of any document signed on behalf of the corporation is of crucial importance.  

Interestingly, the corporate veil may also be pierced in time of war to determine if a corporation is an "enemy alien" or a company incorporated within Canada but controlled by persons who are situate within an enemy territory.

In most cases, lifting the corporate veil would be contrary to the interests of the principal shareholder. As illustrated, the courts will do so only in limited circumstances. However, it is also important to be aware of the scenarios where a principal shareholder of the corporation may desperately want the court to lift the corporate veil. The courts have shown a marked unwillingness to do that and have occasionally suggested that they are less willing to do so for the benefit of the shareholders than for their detriment. A classic example comes from a case where a sole proprietor incorporated to become the sole shareholder but virtually all documentation continued to refer to the sole proprietorship, including a key insurance policy.  When the corporation's assets were damaged, the insurance company argued that the corporation itself had no insurance policy and that the sole shareholder had no insurable interest in the corporation's assets. The Supreme Court of Canada agreed and refused to lift the corporate veil stating that those who have chosen the benefits of the incorporation must bear the corresponding burdens.  

Those entrepreneurs with a potentially booming business should keep in mind that a corporate veil is far more than a fashion accessory in the world of corporate law.

Faruk Gafic practices law with Toronto firm McLean & Kerr LLP, in the areas of commercial real estate and leasing, as well as corporate/commercial law.