When a corporation acts in a manner that causes harm to others, should the shareholders and/or officers of that corporation be held personally liable? Under normal circumstances, the incorporation of a business shields individual shareholders from such liability. A corporation is viewed as an independent legal entity and as such, can be held liable for wrongful acts. This is often viewed as a major benefit of incorporation – it shields those behind the business from personal responsibility in the event of wrongdoing.
However, there are some circumstances in which those individual shareholders can be held personally liable, an occurrence referred to as ‘piercing the corporate veil’. In a recent decision of the Ontario Superior Cout of Justice, the court found that the sole shareholder of a corporation had behaved so egregiously that piercing the corporate veil and holding him personally liable was the only recourse.
What is “Piercing the Corporate Veil” and What are the Requirements?
As mentioned above, one of the major benefits of incorporating a business is the liability issue. Incorporation, in creating a legally independent entity, acts to protect those behind the business from personal liability. However, the court does retain the ability to pierce this corporate identity and assign liability to individual players. In the past, this ability was severely limited to very particular circumstances. At one point it was solely used when a corporation had been incorporated for an illegal, fraudulent or improper purpose. If that could be established, a court was free to hold those behind the business liable for the acts of the business.
In 2014, an Ontario decision known as Shoppers Drug Mart Inc. v. 6470360 Canada Inc. made piercing the corporate veil more accessible and broadened the scope of circumstances in which it could apply. In that case, the court found that any corporation that only has one person acting as an officer, director and shareholder can be pierced, since the directing mind of the incorporated party is easy to discern.
Shoppers is Applied to the Case at Hand
In the case at hand, three American investors (the Plaintiffs) had been persuaded to enter into an investment in a commercial real estate property with the defendant corporation, which had a single officer and shareholder. When the Defendant decided to sell the property and reinvest the proceeds, he did so without consulting the plaintiff investors. The defendant officer, acting in his capacity as the corporation, then sold that property six years later for a profit, after collecting rent from commercial tenants over this course of his ownership.
During the intervening years, the Plaintiffs had made inquiries about their investment. The Defendant had deflected questions and failed to provide them with satisfactory information. In addition, he lied directly lied to them and hid the fact that he had sold the initial investment property from them. He further agreed to provide financial records after initially saying the information had been lost in a flood. In reality, he had sold the property before the years for which the Plaintiffs wanted the records, and he had not disclosed this fact.
The Court, when assessing the Defendant’s personal liability, weighed the factors before determining that this was appropriate in the case at hand:
Although the starting presumption is that a corporation is a separate entity, the corporate veil can be pierced if those in control expressly direct a wrongful act to be done…[The Defendant] used [the corporation] as his alter ego. He directed and caused the misappropriation of the Plaintiff’s trust funds for his own purposes. I find [the Defendant] to be personally liable to the Plaintiff for funds the Plaintiff contributed to the [initial investment].
In addition to personal liability for the funds, the Defendant was also found liable for punitive damages, due to the egregiousness of his actions. The Court held:
[The defendant] lied to the Plaintiff Principals, not once, but on a regular and recurring basis for more than six years. He used their funds to enrich himself. I find that his behaviour in that regard was outrageous, reprehensible and not be countenanced. It calls for a strong denunciation by this Court.
Takeaways for Shareholders and Those Considering Incorporation
While incorporation is an excellent way to limit personal liability, it is important to remember that egregious acts of deception, fraud or other deceitful or harmful actions will not be taken lightly. Acts of this nature will make a court more inclined to go behind the corporation and look to hold officers and shareholders liable in a personal capacity. Further, when there is only one officer and/or shareholder, this makes the act of piercing the corporate veil a much easier prospect in litigation and may result in costly orders against officers and shareholders in their personal capacity.
The skilled business lawyers at GLG LLP in Toronto regularly assist organizations of all sizes and structures with a variety of issues, including configuration and structure of the venture in a way that be most beneficial to those involved. Further, we advise and represent corporate clients on related matters including commercial real estate ventures and litigation if necessary. Call 416-272-7557 or complete the online form to arrange a consultation with one of our lawyers today.