Corporate Liability During Insolvency

• Author: Stephanie Ben-Ishai; Thomas G. W. Telfer
• Pages: 343-414

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CHAPTER 10

Corporate Liability During Insolvency

I. INTRODUC TION

When a corporation is insolvent, should directors take some responsibility for its debts?

Should the directors incur personal liability either to the debtor company or directly to the

creditors themselves, most notably for the actions they took during the time the corporation

was nancially distressed? The starting point for these issues is always the basic company

law principle that the corporation is a separate legal entity and is therefore distinct from its

members. This starting point, however, does not exist in a legal vacuum, since, practically,

the company is a legal ction and directors and ocers are the agents, the ones who exer-

cise the will of the company. Directors control the company’s aairs and they know about

the company’s nances. This has led to numerous legislative provisions that allow directors

to be held personally liable for some of the debts of the corporation. Part II of this chapter

considers a range of Canadian statutes which impose that liability on directors (see, for

example, Janis Sarra and Ronald Davis, Director and Ocer Liability in Corporate Insolvency:

A Comprehensive Guide to Rights and Obligations, d ed (Markham: LexisNexis, ) at –).

Director liability arises for unpaid wages under federal and provincial corporation statutes,

as well as under employment standards legislation. Similarly, directors face the prospect of

personal liability for unpaid remittances by the corporation of income tax.

When a debtor corporation is in nancial distress and the directors engage in conduct

that is detrimental to creditors, the directors can be subject to sanctions. See Part III of this

chapter for this issue. Under corporate law, directors owe a duciary duty to the corporation,

to act in the best interests of the corporation. Creditors in Canada have been attempting

to expand this duty for years, arguing that the duty should encompass creditors when the

corporation is insolvent or in the vicinity of insolvency, as creditors become the residual

owners of the corporation at that time. Canada, England, Australia, New Zealand, and the

United States have all considered this question, in varying forms. Part III examines how the

Supreme Court of Canada addressed that question, as well as what it said about other rem-

edies creditors can use in these circumstances, in Peoples Department Stores Inc (Trustee of)

v Wise (Peoples Department Stores). The chapter includes a study of the Canadian oppres-

sion remedy and a comparative examination of wrongful or reckless trading statutes found

in other jurisdictions. While the parameters of the topic of director liability are wide, this

chapter focuses on specic instances of director liability in the context of bankruptcy and

insolvency.

 BANKRUPTCY AND INSOLVENCY LAW IN CANADA: CASES, MATERIALS, AND PROBLEMS

II. DIRECTORS’ PERSONAL LIABILITY FOR CORPORATE DEBTS

A. Federal Liability Under the Canada Business Corporations Ac t

Under the Canada Business Corporations Act, RSC , c C- (CBCA), directors are held liable for

unpaid employee wages. Section  holds directors jointly and severally liable to employees of

the corporation for the debts not exceeding six months wages payable to each employee for the

services performed for the corporation while they were directors. Directors also have a due dili-

gence defence, as in, they will not be liable if they exercised the care, diligence, and skill that a

reasonably prudent person would have exercised in comparable circumstances (CBCA, s ()).

As noted by L’Heureux-DubéJ in Barrette v Crabtree Estate, []  SCR  (Barrette),

below, the remedy against directors for unpaid wages can be traced back to the nineteenth cen-

tury. Eric Tucker, in “Shareholder and Director Liability for Unpaid Workers’ Wages in Canada:

From Condition of Granting Limited Liability to Exceptional Remedy” ()  Law & History

Review  at – (footnotes omitted), describes the history as follows:

The recurring demand for wage protection arises from the near universal practice of

paying workers in arrears — that is, after they have provided service. As a result, work-

ers become their employers’ creditors and bear some risk that they will not be paid. It

is clearly unacceptable, however, for workers not to be remunerated for the service they

provided: non-payment of wages is a breach of employers’ most fundamental contrac-

tual obligation to workers. It is a cause of hardship to workers and their dependent

family members who, without the cushion of signicant savings or accumulations of

property, rely on wages to meet their basic needs. . . .

[I]n parts of Canada and the United States the demand for wage protection did not

arise to confront a preexisting corporate law, but was present in the process of its creation,

needing to be accommodated in the rst general incorporation statutes. Numerous Can-

adian and American legislatures responded to this demand by making shareholder and

later director liability for unpaid workers’ wages a condition of granting widespread

access to the privilege of forming limited liability corporations. Yet within a short time,

judicial decision making inverted this understanding of the conditionality of limited lia-

bility. It reconstructed limited liability as a basic norm of capitalist legality rather than as

an exceptional privilege. In so doing, the courts also transformed the protection of work-

ers’ wages from a normative and legal condition of granting corporate investors and

managers the privilege of limited liability into an exceptional privilege granted by the

state in derogation of the norm of limited liability. Then, on the basis of this inversion,

judges narrowly interpreted the scope of director liability for unpaid workers’ wages

both in relation to who and what was protected.

Employees are a particularly vulnerable group in a bankruptcy, since “[u]nlike other credit-

ors, employees are likely the last to know that a rm is failing. Employees are not able to

diversify their credit risk and are unable to switch employers at the rst sign of trouble”

(Thomas Telfer, “Justice Rand’s Commercial Law Legacy: Contracts and Bankruptcy Policies”

()  Manitoba Law Journal  at ). To that end, as L’Heureux-Dubé J notes in Barrette,

the “primary purpose of the remedy . . . is to protect employees in the event of bankruptcy or

insolvency of the corporation” (para ). Other courts have expressed similar sentiments. The

British Columbia Court of Appeal in Canadian-Automatic Data Processing Services Ltd v Bentley,

 BCCA  at para , oered the same rationale for director liability in the British Colum-

bia Employment Standards Act, RSBC , c :

Chapter : Corporate Liability During Insolvency 

The obligation of corporate directors and ocers under the Employment Standards Ac t is

a statutory exception to the general rule that the separate legal personality of a corpora-

tion insulates principals of the company from liability for its debts. The justication for

this exception is the particular vulnerability of employees compared to other creditors.

The provision is typically used when the corporation is experiencing nancial diculty.

On the other hand, the provisions that impose personal liability on directors have typ-

ically been seen as an exception to the principle of limited liability. This is likely a misappre-

hension of the principle of limited liability, but it has not prevented courts from consequently

interpreting these types of provisions narrowly. Limited liability is one of the bedrocks of

corporate law and courts are jumpy at interfering with it. In Archibald, Re, [] BCESTD No

 at para , the court maintained,

[O]ur Court of Appeal and the Supreme Court of Canada have both recognized that the

imposition of a personal unpaid wage liability on corporate ocers and directors is an

extraordinary exception to the general principle that directors and ocers are not per-

sonally liable for corporate debts. Accordingly, while the Act as a whole is to be inter-

preted in a broad and generous fashion, the provisions imposing a personal liability on

corporate directors and ocers should be narrowly construed.

In fact, however, the principle of limited liability applies to shareholders in the course of

acting as shareholders (CBCA, s ). With regard to directors, it does not apply to provide

blanket immunity to them in the course of carrying out their duties to the corporation, but it

does apply to exclude them from liability from actions involving breach of the corporation’s

contracts. Hence, if directors are to be held personally liable for these types of contracts, an

explicit provision is necessary. Therefore, section  is required if directors are to be held

liable for employee wages.

Interpreting these provisions narrowly does not only arise from fear of violating the prin-

ciple of limited liability; it also arises from other factors. Fear of causing a chilling eect on

directors is a signicant consideration. Directors may resign once they know a corporation

is struggling, fearing personal liability for its debts. The chill can also discourage qualied

people from accepting directorships. For general commentary see Bryan Haynes, “Directors’

Liability for Termination Pay: Barrette v. Crabtree Estate” () : Canadian Business Law

Journal ; Shak Bhalloo and Devin Lucas, “Section  of the Employment Standards Act:

Balancing Competing Interests” ()  Advocate .

Barrette v Crabtree Estate, []  SCR 

L’HEUREUX-DUBÉ J:

[] This appeal concerns the interpretation of s.() of the Canada Business Corporations

Act, SC --, c. (“C.B.C.A.”) (now s.() of the Canada Business Corporations Act,

RSC, , c.C-). Specically, the question is whether, under that provision, the direc-

tors of a corporation against which employees have obtained a judgment, can be held per-

sonally liable for sums of money awarded by a court as pay in lieu of notice of dismissal. . . .

I. Facts

[] On May ,  Wabasso Inc. (hereinafter “the corporation”) closed its plant at

Trois- Rivières after experiencing serious nancial diculties. The appellants,  former