Not so many years ago, anyone planning on going into business was strongly advised to incorporate a company in order to take advantage of limited liability. In fact, the company's name had to end with the word "Limited". While the legal concept may still be in force, there are now so many liabilities imposed on directors that one could be forgiven for being a bit cynical about the merits of incorporation.

Anyone who is involved as a director or officer of a business corporation experiencing financial difficulties that may lead to bankruptcy or receivership should be aware of the principal liabilities to which such person may be exposed. Even if the principal liabilities leads inevitably to the conclusion that the director must also resort to bankruptcy as a solution, it will be an important consideration to know which liabilities carry criminal sanctions that bankruptcy will not cure.

Directors have always had liability for the management of the corporation and for breach of financial duty. With the passage of time, laws have been passed imposing liability on the directors and others that may be running the corporation for payment of employee wages, taxes, corporate improprieties, and now environmental pollution. While there are at present over 100 statutes that impose civil or criminal liabilities on directors, this paper is intended to deal with the most common problems that directors will encounter in their business.

In reviewing these liabilites, we will be giving a priority to those that are most likely to impact on the individual concerned. We will be looking at the respective statutes with the following in mind:

   (i)    Is the breach one of strict liability so that intent is not required?

   (ii)    Are there any defences available?
               - due diligence
               - lack of guilty intent

   (iii)    Are there potential criminal charges?

   (iv)    Are there assets that stand charged with the liability?

   (v)    Will a third party such as a receiver have to pay the liability out of secured assets?

   (vi)    Are there limitation periods?

   (vii)    Will Others be required to contribute?

   (viii)    Will bankruptcy of the corporation solve or complicate the problem?

   (ix)    Is there sufficient cash flow and time available to rectify the problem or to establish a trust fund for the liability?

   (x)    Is there insurance for directors and officers that covers the liabilty?

   (xi)    Are there others who are liable to indemnify?

   (xii)    Is there time to resign and avoid further liability?

The legislative scheme generally is an attempt to compel the corporation to comply with regulations, and enforce them against the assets of the corporation, through security, deemed trusts, or fines and penalties. It is only as a last resort that the directors will be called upon to honor the corporation's obligations.
DIRECTORS' GENERAL DEFENCES

(a) Civil Defence of Due Diligence

The most common defence is "due diligence", which means that the directors and officers did not know and could not reasonably have known of the breach, or that they exercised a degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances to prevent a contravention.  The director cannot have simply ignored the situation. There must be some positive step taken to address the problem.

Were procedures established that should have ensured payment? Did the directors lose control to the bank or a receiver? Was the director a nominee and not active in the business? Did the director rely on statements from accountants?

(b) Criminal Defence of Lack of Mens Rea

Under the Criminal Code, there are complicity provisions which would render directors liable in certain instances if they directly participated in the commission of an offence. Many of the other statutes which create a civil liability on directors also provide for a criminal complicity provision on an indirect basis and set out the nature of the action or passive action giving rise to such liability.

In addition to proving that the director committed the particular act specified in the statute, the accused must have had a "guilty mind"; that is, there must have been an intention to do something known to be wrong. There must be something more than mere negligence. If a director has knowledge that an offence has been committed or is about to be committed, and is in a position to take corrective or preventative measures, the individual should attempt to do so. Even if the offence is not avoided, it will go to the lack of guilty intent if a charge is subsequently  laid.

In the 2000 economic climate, it would be a rare case in which criminal charges would be laid against a director. That is not to suggest that the legal right to lay charges may not be exercised under improved financial circumstances. The principal purpose of the criminal sanction is to emphasize to directors that they have a duty not to use money that does not belong to the corporation.
LIABILITY TO EMPLOYEES

Protection for employees has long been an object of legislation. Directors are responsible not only for wages but also certain benefits such as vacation pay. However, so far, they have been immune from severance, termination or wrongful dismissal liability.

(a) Ontario Business Corporations Act

Directors are liable for all debts not exceeding six months wages payable to employees for services performed for the corporation, and for up to twelve months unpaid vacation pay, during the period that they were directors.

Employees must commence an action against the employer (unless already bankrupt) and the directors within six months after debts became payable, at a time that the director is still a director or within six months of the director having resigned.

A director who pays the obligation is entitled to any preferred claim that the employee would be entitled to under the bankruptcy of the employer. The director is also entitled to contribution from any other directors.

Section 131

(b) Canada Business Corporations Act

The liabilities are substantially the same as under the Ontario statute , except that the limitation period for suing a director is two years.

A director has a defence if there was bona fide reliance on a financial statement or report from some professional that gives it credibility.

Sections 119, 123

(c) Employment Standards Act

Originally, this Ontario statute was intended to provide minimum employment standards including vacation pay. It has now been extended to include the Employee Wage Protection Program which is intended to provide for almost immediate payment to employees by the government which will then recover from the employer or directors. Directors may be liable to criminal sanctions in addition to civil liability.

Officers, directors and agents may be charged criminally if they authorized, permitted or acquiesced in the contravention of a provision of the Act by the corporation, whether or not the corporation has been prosecuted or convicted. It will be necessary to prove that the corporation has been guilty of the contravention even if there has been no conviction.

Section 79

In addition to any penalty imposed, which may be a fine or imprisonment, the court may order the amount unpaid to be paid by the director to the Director of Employment Standards who will make a distribution to the employees.

Section 79 (3)

Criminal charges are rarely laid under the Act. This is reflected in the unusual procedure set out in the statute providing that no prosecution can take place without the written consent of the Director of Employment Standards.

Section 79 (4)

The Act also provides for directorsí liability to pay wages and vacation pay, parallel to the provisions of the Ontario Business Corporations Act.  However, there is a summary procedure for obtaining judgment against directors simply by an order of an employment standards officer.

There is a two year limitation period after the obligation arises in which to assess directors.

Section 58.19 et seq.

Vacation pay that has not been paid to employees constitutes a "deemed trust" and therefore may be a priority over secured creditors along with the deemed trusts that have been created under other statutes. However, the priority is lost on the bankruptcy of the employer and vacation pay will only rank as an unsecured claim.

Directors will continue to have personal liability, so it may be to their benefit to see that the deemed trust is effective.

A lien or charge is also created over the assets of the employer for unpaid vacation pay which constitutes a deemed trust. However, the lien does not have priority over secured creditors other than to the extent that the deemed trust is enforceable.

Section 15

(d) Ontario Pension Benefits Act

If an employer receives money from an employee as the employeeís contribution to a pension fund, the employer is deemed to hold it in trust for the employee until it is paid into the fund. Similarly the employerís contributions are deemed to be held in trust for the beneficiaries of the plan if they are not paid into the fund. This has no effect if the employer goes into bankruptcy.

The administrator of the pension plan has a lien or charge on the assets of the employer to the extent of the deemed trust money unremitted. However, the lien does not have priority over secured creditors other than to the extent that the deemed trust is enforceable.

Section 58

Officers, directors, officials and agents may be charged criminally if they directed, authorized, assented to, acquiesced in, or participated in the contravention of a provision of the Act by the corporation and the corporation is guilty of the offence, whether or not the corporation has been prosecuted or convicted.

In addition to any fine imposed on the director, the court may order the director to pay the amount unpaid to be paid to the pension fund or insurance company.

Section 110

There is a five year limitation period for prosecuting under the Act.

(e) Pension Benefits Standards Act

The provisions under the federal statute (which will apply to corporations incorporated under the Canada Business Corporations Act) are almost identical to the provincial legislation, except that the penalty for contravention will also include imprisonment.

Sections 8, 21,  38

(f)    Employeesí Source Deductions
       Income Tax Act
       Canada Pension Plan
       Unemployment Insurance Act

An employer is required to deduct from an employeeís wages moneys for income tax, CPP and UIC. These moneys are to be remitted in the month following the deduction. Unfortunately, employers that are in a financial squeeze tend to ignore the obligation and forget that if they use this money in the business operations, they are effectively stealing the funds from their employees. The law recognizes that position and imposes sanctions accordingly.

Officers, directors and agents may be charged criminally if they directed, assented to, authorized, acquiesced in, or participated in the contravention of a provision of the relevant statute by the corporation, whether or not the corporation has been prosecuted or convicted. It will be necessary to prove that the corporation has been guilty of the contravention even if there has been no conviction.

   Income Tax Act,   s. 242
   Canada Pension Plan,   s. 103
   Unemployment Insurance Act,   s. 74

Directors are liable jointly and severally with the corporation to pay all amounts deducted and not remitted by the corporation, together with all penalties and interest.

A director has the following defences to the civil liability:

       (i)    Due diligence;
       (ii)   Neither of the following requirements have been established:
               Certificate of the corporationís liability must be registered with the Federal Court and execution returned unsatisfied; or
               The corporation has gone into bankruptcy and a claim for the liability has been proven within six months;
      (iii)   Action has not been taken within two years after ceasing to be a director.

   Income Tax Act,  s. 227.1
   Canada Pension Plan,  s. 21.1
   Unemployment Insurance Act,  s. 54

All deductions from wages are deemed to be held in trust for the Crown, and form no part of an estate in receivership or bankruptcy, notwithstanding the fact that they have not been kept separate and apart. This provision means that the Crown has a super-priority over all assets of the corporation, including claims of secured creditors. The bankruptcy of the corporation will not alter that position.

   Income Tax Act,   s. 227.1
   Canada Pension Plan,  s. 23
   Unemployment Insurance Act,    s. 57
   Bankruptcy and Insolvency Act,  s. 67 (2) (3)

Bearing in mind the superpriority given to the  employeesí deductions, so long as there are any assets of the corporation in existence, regardless of whether or not they are secured, there is very little concern as to the directorsí ultimate liability.

(g) Occupational Health and Safety Act

This statute is designed for the protection of employees to ensure that they have a safe place to work. Directors and officers have  a specific responsibility to take all reasonable care to ensure that the corporation complies with the regulations and orders of the Act. This would appear to establish some sort of standard of diligence, not related to the guilt of the corporation.

Section 66

(h) Workersí Compensation Act

The Workersí Compensation Act is provincial legislation and provides a lien against property of the employer under certain circumstances.

However, there is no liability on directors for non-payment of assessments.
LIABILITY FOR TAX COLLECTION

(a) Excise Tax Act  -   Goods and Services Tax

A corporation is required to collect and remit GST in a similar fashion to employee deductions. Failure to do so gives rise to both civil and criminal liability for directors.

Officers, directors and agents may be charged criminally if they directed, assented to, authorized, acquiesced in, or participated in the contravention of a provision of the Act by the corporation, whether or not the corporation has been prosecuted or convicted. It will be necessary to prove that the corporation has been guilty of the contravention even if there has been no conviction.

Section 330

Directors are liable jointly and severally with the corporation to pay all amounts collected and not remitted by the corporation, together with all penalties and interest.

A director has the following defences to the civil liability:

       (i) Due diligence;

       (ii) Neither of the following requirements have been established:
            Certificate of the corporationís liability must be registered with the Federal Court and execution returned unsatisfied; or
            The corporation has gone into bankruptcy and a claim for the liability has been proven within six months;

      (iii) Action has not been taken within two years after ceasing to be a director.

Section 323

GST that has been collected but not remitted constitutes a "deemed trust" and therefore may be a priority over secured creditors along with the deemed trusts that have been created under other statutes. However, the priority is lost on the bankruptcy of the employer and GST will only rank as an unsecured claim. Directors will continue to have personal liability, so it may be to their benefit to see that the deemed trust is effective.

Section 222

(b) Retail Sales Tax Act

A corporation is required to collect and remit provincial sales tax (PST) in a similar fashion to GST. Failure to do so gives rise to both civil and criminal liability for directors.

Officers, directors and agents may be charged criminally if they directed, assented to, authorized, acquiesced in, or participated in the contravention of a provision of the Act by the corporation, whether or not the corporation has been prosecuted or convicted. It will be necessary to prove that the corporation has been guilty of the contravention even if there has been no conviction.

Section 42

Directors are liable jointly and severally with the corporation to pay all amounts collected and not remitted by the corporation together with all penalties and interest.

Section 43

A director has the following defences to the civil liability:

       (i) Due diligence;
       (ii) Neither of the following requirements have been established:
            A warrant of execution for the amount of the corporationís liability must be filed with the sheriff of the district where property is located, and the warrant returned unsatisfied; or
            The corporation has gone into receivership, bankruptcy, or filed a proposal, and a claim for the liability has been proven within six months;
      (iii) Action has not been taken within two years after ceasing to be a director.

PST that has been collected but not remitted constitutes a "deemed trust" and therefore may be a priority over secured creditors along with the deemed trusts that have been created under other statutes. However, the priority is lost on the bankruptcy of the employer and PST will only rank as an unsecured claim. Directors will continue to have personal liability, so it may be to their benefit to see that the deemed trust is effective.

Section 22

(c) Employer Health Tax Act

All employers are required to pay a tax based on the total payroll of the business. Self employed individuals will also have to contribute if they earn more than $40.000.00.

Officers, directors and agents may be charged criminally if they directed, assented to, authorized, acquiesced in, or participated in the contravention of a provision of the Act by the corporation, whether or not the corporation has been prosecuted or convicted. It will be necessary to prove that the corporation has been guilty of the contravention even if there has been no conviction.

Section 36

There is no civil liability imposed on directors for failure to pay.

There is a lien provided for against the corporationís real and personal property, but in order for it to be effective it must be registered against the land or a Financing Statement filed pursuant to the PPSA. The lien will then continue for a period of three years unless renewed.

Section 23

There is no deemed trust concept applicable.

(d) Corporations Tax Act

A corporation is required to file corporate tax returns. If they are not filed, the directors can be liable for criminal charges.

Officers, directors and agents may be charged criminally if they directed, assented to, authorized, acquiesced in, or participated in the contravention of a provision of the Act by the corporation, whether or not the corporation has been prosecuted or convicted. It will be necessary to prove that the corporation has been guilty of the contravention even if there has been no conviction.

There is no civil liability imposed on directors.

There is a limitation period of six years in which to prosecute charges.

Sections 95, 96, 97

(e) Corporations Information Act

Corporations are from time to time required to file returns. If any statements in the returns are false and misleading with respect to any material facts, the directors and officers who authorized, permitted or acquiesced in  the offence are also guilty and subject to a fine and/or imprisonment.

In order to defend, the director must show that he did not know that the statement was false and misleading and, with reasonable diligence, could not have known.

The failure to file a return when required is also an offence. Officers, directors and agents may be charged criminally if they directed, assented to, authorized, acquiesced in, or participated in the contravention of a provision of the Act by the corporation, whether or not the corporation has been prosecuted or convicted. It will be necessary to prove that the corporation has been guilty of the contravention even if there has been no conviction.

There is no civil liability imposed on directors.

There is a limitation period of two years in which to prosecute charges.

Sections 13, 14, 15

(f) Employeesí Source Deductions

For a discussion of this issue, see paragraph (f) under Liability to Employees.
LIABILITY FOR IMROPER CORPORATE PROCEEDINGS

There are a number of proceedings that can give rise to directorsí liability that generally apply in an insolvent situation. While not particularly common, a director should be aware of the problems in order to avoid them.

(a)    Ontario Business Corporations Act
       Canada Business Corporations Act

A director may be liable to the corporation if certain acts are done when the corporation was insolvent or that would have rendered it insolvent. The following are some of the common offending transactions:

       (i) purchasing or redeeming its own shares;

       (ii) declaring dividends;

       (iii) paying commissions on sale of shares;

       (iv) granting financial assistance to certain related corporations.

   Canada Business Corporations Act,  ss. 34-36, 42. 118
   Ontario  Business Corporations Act,  ss. 30-32, 38, 130

The following defences are available:

       (i) The director did not vote for or consent to the resolution;

       (ii) The director was absent and  dissented within seven days of learning of the resolution;

       (iii) The director relied in good faith on the financial statements or auditorsí report or report of another professional.

If the director repays the money, he may be entitled to obtain a court order directing the shareholder who received the money to repay it to the director.

There is a two year limitation period from the date of the resolution in order to enforce the liability,

(b) Bankruptcy and Insolvency Act

A trustee may obtain judgment against the directors of a bankrupt corporation who declared a dividend or redeemed shares, or against a related shareholder who received a dividend or had shares redeemed, if a corporation

       (i) within twelve months prior to bankruptcy;

       (ii) paid a dividend, redeemed shares, or purchased shares for cancellation;

       (iii) when the corporation was insolvent, or if the transaction rendered the corporation insolvent.

Bankruptcy and Insolvency Act,  Section 101

The only defences available are:

        (i) The shareholder is not related to the corporation or to any of the directors;

       (ii) The shareholder has repaid any moneys received from the transaction;

       (iii) The director who has protested against the transaction is exonerated;

       (iv)  The moneys paid pursuant to the transaction have been repaid to the corporation;

       (v) The payment of dividends can be characterized as compensation in lieu of salary.

Re Waterloo Mechanical Contractors Ltd.       (1983), 49 C.B.R. (N.S.) 196

The onus of establishing that the corporation was not insolvent, or was not rendered insolvent by the transaction, is on the directors and shareholders.

These provisions do not supplant any other corporate legislation that may have a similar effect.

There is no limitation period to attack this transaction.
LIABILITY UNDER CONSTRUCTION CONTRACTS

Construction Lien Act

Every director and officer, as well as any employee or agent who has effective control of the corporation or its activities, who assents to , or acquiesces in, conduct that he knows or reasonably ought to know amounts to a breach of trust by the corporation , is liable for the breach of trust.

This means that a director may be liable if moneys that came from a construction contract do not get paid to creditors that worked on the job or provided materials to the job.

Section 13

LIABILITY FOR ENVIRONMENTAL PROTECTION

There are now a series of statutes which create liabilities for any damage to the environment, or more importantly, for breaching rules that could lead to serious damage to the environment. It is more important to prevent an Exxon Valdez  disaster than to penalize the perpetrators. Directors are also subject to criminal prosecution for the acts  or omissions of the corporation, or for their own acts or neglect, since some of the statutes impose a duty on the director to take care not to permit the corporation to violate the statute.

(a) Environmental Protection Act

This Ontario statute creates a duty on directors and officers of a corporation to take all reasonable care to prevent the corporation from causing or permitting an illegal discharge of contaminants into the natural environment. A failure of that duty gives rise to an offence.

Again it is not necessary that the corporation be prosecuted or convicted.

There is a two year limitation  on prosecution from the later date of the offence or when it was discovered.

Sections 194, 195

(b) Environmental Contaminants Act

This federal statute states that no person shall, in the course of a commercial, manufacturing or processing activity, wilfully release, or permit the release, of a specified substance into the environment in greater than prescribed quantities.

Officers, directors and agents may be charged criminally if they directed, assented to, authorized, acquiesced in, or participated in the contravention of a provision of the Act by the corporation, whether or not the corporation has been prosecuted or convicted. It will be necessary to prove that the corporation has been guilty of the contravention even if there has been no conviction.

The limitation period for prosecution is one year from when the subject matter of the proceedings arose.

Sections 17, 24, 26

(c) Transportation of Dangerous Goods Act

This federal statute provides for the safe handling and marking of dangerous goods.

Officers, directors and agents may be charged criminally if they directed, assented to, authorized, acquiesced in, or participated in the contravention of a provision of the Act by the corporation, whether or not the corporation has been prosecuted or convicted. It will be necessary to prove that the corporation has been guilty of the contravention even if there has been no conviction.

The corporation has a defence if it can show that the offence took place without its knowledge and it had taken all reasonable measures to prevent the offence.

It is a defence to establish that all reasonable measures were taken to comply with the Act and its obligations.

Sections  4, 8,  10, 11

(d) Dangerous Goods Transportation Act

The Ontario statute parallels  the federal statute but limits its application to the transportation of goods in a vehicle on the highway. In all other respects it is identical including the due diligence defence.

Sections 3, 5, 6, 7

(e)    Ontario  Water Resources Act
       Pesticides Act

These Ontario statutes create a duty on directors and officers of a corporation to take all reasonable care to prevent the corporation from causing or permitting an illegal discharge of contaminants into the water, or to impair the quality of the environment, or damage property or animal life. A failure of that duty gives rise to an offence.

Again it is not necessary that the corporation be prosecuted or convicted.

There is a two year limitation  on prosecution from the later date of the offence or when it was discovered.

   Ontario Water Resources Act,   s. 116
   Pesticides Act,  ss. 48, 49