What business debts will I be personally responsible for?

There are many benefits to operating your own business when the business is successful, but what happens when it’s struggling. According to Industry Canada, only 51% of new small-to-medium size businesses are still operating after their first 5 years. A number of businesses will wind down in a controlled method so that there are no outstanding liabilities, but some businesses are forced to shut down due to insolvency. One of the concerns for the owners of an insolvent business, is what will be their personal financial responsibilities with regards to the remaining business debts. 

The answer will depend upon the company’s legal structure. The two most common legal structures are a proprietorship or a corporation.

Proprietorship

A proprietorship is a form of business ownership where the individual owners and the business are the same legal entity. The assets of the company are also assets of the owner and the liabilities of the business are also the liabilities of the owner. As a result, if the business ceases operation, then the owner will become personally responsible for any remaining debts.

Corporation

Corporations are a form of business ownership where the individual owners and the business are two distinctly separate legal entities. When the business winds down or becomes insolvent most liabilities will not flow to the corporation’s owners, except for certain debts as a result of contractual obligations or statute.

Contractual obligations are debts that will transfer to you pursuant to a written contract. A common example is a small business loan. Due to the nature of a small-to medium-size business, it is a common practice for banks to require a personal guarantee for a loan. Also, many landlords will require a personal guarantee for a lease. There may be other situations where a supplier of goods or services may require a personal guarantee. When a personal guarantee is provided, it will take affect when the business ceases to pay or become insolvent.

The second type of liability is the result of a statute. The most common is for unpaid employee source deductions and unpaid GST and/or HST. In this situation, the directors of the corporation become personally liable to Canada Revenue Agency to pay the outstanding amounts (similar statutes, depending upon the province, may exist for unpaid provincial sales taxes). Depending upon the province, there may be legislation which holds the directors and/or shareholders responsible for other types of liabilities such as outstanding employee wages and vacation pay, amounts due under a constructions lien holdbacks as well as others legislated amounts.

Options

The debts that flow to either a business owner of a proprietorship or a shareholder and/or director are treated like other personal debts. The business owner or shareholder and/or director can pay the liabilities or they may have to file a proposal or personal bankruptcy.

Creditor proofing

Individuals who are about to set up a corporation, should consult with a professional how best to creditor proof themselves personally. This is the process of structuring your personal assets so that they would not be exposed if your small business is not successful. For the process to be effective, it should be developed during the start-up of your new business.

If you are a business owner or a shareholder and/or director of a company that has ceased operations and has outstanding debts, you should consult with a professional from MNP to determine your best course of action.