An incorporated company is a separate, distinct legal person. The "corporate veil" is a term used to describe how incorporation can shield the personal assets of the individuals running the business as well as its owners. Individuals frequently conduct business through numbered companies to avoid personal liability. The numbered company will be the legal person that holds title to the assets of the business. While the corporation as a legal entity was created to encourage business development and risk taking, the corporation has also been used to shelter personal assets from creditors or former spouses and to avoid personal liability for the individual's actions in operating the business.
Notwithstanding the fact that a corporation is a distinct legal entity separate from its officers, directors and shareholders, in some situations a court will disregard the separate legal personality. This has been called piercing the corporate veil. Canadian courts have pierced the corporate veil when the corporation has been completely dominated by a single person or if the corporation has been used as a shield for fraudulent or improper conduct. The two primary factors considered by the courts in deciding whether to breakdown the protection usually afforded by incorporation are:
- The degree of control of the shareholders or directors over the corporation, and
- The nature of the wrongful act.
Fortunately for those who want the protection, the courts are usually very reluctant to lift the corporate veil and hold the guiding minds of the corporation personally liable for the corporation's actions. There is no single situation or consistent test applied by the courts when someone asks the court to lift or pierce the corporate veil and treat the company as a mere "agent" or "puppet" of its controlling shareholder or parent corporation. There are a number of factors that the courts will consider to ascertain whether the degree of control is so high that the corporation is a "sham, cloak or alter ego" and those include: where the shareholder intermingles the corporation's affairs with their own personal affairs; where the corporation is not independent from its shareholders; where the corporation does not have its own assets, skills or employees; and where the corporation does not have its own bank account, books or records. The courts will also look at whether declining to pierce the corporate veil will allow injustice to be visited on a party.
A leading case on piercing the corporate veil in Ontario of Lynch v. Segal, 2006 CanLII 42240 (ON CA), involved an individual named Moses Segal who the court described as an "extraordinarily wealthy" man. Mr. Segal admitted to having a net worth exceeding $100,000,000. During divorce proceedings of Mr. Segal and his wife, Cynthia Lynch, the court found that Mr. Segal shielded almost all of his personal assets inside corporations. The court determined that it would not permit those assets to be shielded from the matrimonial proceedings as the result of declining to pierce the corporate veil would be to deny Ms. Lynch her rightful access to assets of the marriage.
While there is no doubt that corporate entities play a very important role in limiting the liability of officers, directors and shareholders from business or litigation risk, the protection offered by corporations is not absolute. To bolster the protection afforded by incorporation, steps should be taken to ensure that the corporation exists and operates as a separate entity rather that just existing on paper. The corporation should have its own phone number, bank accounts, contracts and employees. Shareholders must not treat the corporation as the repository of their personal assets or as their "personal" business, but take steps to acknowledge and act as if the corporation has its own separate and distinct identity.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
