Skirting the Corporate Veil

(Originally published in Lawyer’s Weekly, Feb 7 2003)

All commentators and judges agree on one thing about the remedy of piercing the corporate veil, the cases on this subject cannot be reconciled.  There is no clear principle to guide a lawyer advising a plaintiff client on when the corporate form will be ignored.

A review of the cases indicates that the corporate veil will seldomly be pierced.  However, if the question is asked: “when will shareholders be made liable for corporate debts?”, there appears to be an answer: shareholders will be found liable whenever assets are paid to shareholders after the plaintiff’s debts becomes known to the corporation and the corporation is unable to pay them.

Damages of $539,658.41 and punitive damages in the amount of $300,000.00 were recently awarded against shareholders in C. C. Petroleum Ltd. v. Allen et al. [2002] O.J. No. 2203

In that case the shareholders engaged in a cheque  kiting scheme to make the company appear solvent.  However, after the corporation’s insolvency nearly $400,000 was paid by the corporation to shareholders and their law firms.

Some of the shareholders, who held a general security agreement over the corporations assets, appointed a private receiver under the agreement and then obtained a court order confirming the appointment allegedly “on consent” but without notice to the plaintiff.  That receiver collected and disbursed to shareholders and their lawyers another $370,000.

O’Driscoll J., applying well established case law, found that the plaintiff as a trade creditor was a complainant under s. 245 (c) of the OBCA and had status to bring an Oppression Remedy Application under s. 248 of the same Statute.  The payments to the shareholders while the company was insolvent were oppressive conduct.

On the issue of punitive damages, O’Driscoll J. said that even though they are rarely to be granted, the circumstances here were so extreme that punishment was needed.  He also affirmed that punitive damages can be awarded in the absence of an accompanying tort.  The defendants also had to account for all money received by each of them from the corporation or receiver to the Trustee in Bankruptcy.

The action was discontinued against the law firms involved.  As his final comment, O’Driscoll J. said that his failure to comment on the conduct of the law firm might be interpreted as an approval of their conduct.  “Nothing to be further from the truth.  The actions and conduct of each firm, as recited in these Reasons, shocked me beyond words.”

What is curious about the line of cases, of which C.C. Petroleum is one of the most recent, is that they do not usually appear in any texts or articles discussing  piercing the corporate veil or related topics.

The break through in this area came with the recognition that a creditor could use the oppression remedy whenever assets were paid to shareholders or others in preference to creditors. (SCI Systems, Inc. v. Gornitzki Thompson & Little Company (1997), 147 D.L.R. (4d) 300, (Ont.Ct.Gen.Div.))

The oppression remedy is less expensive than bankruptcy proceedings, and there is no requirement to share the proceeds with other creditors.

The scope of liability was quickly extended so that even an unbilled creditor had status to claim the value of work in progress.  Gignac, Sutts v. Harris (1997), 36 B.L.R. (2d) 210 (Ont.Ct.Gen.Div.)

There has been a number of successful shareholder liability cases in recent years.  I am indebted to Marko Djurdjevac of Deacon, Spears Fedson & Montizambert for the following:  Downtown Eatery (1993) Ltd. v. Ontario [2001] O.J. No. 1879; Sidaplex-Plastic Suppliers Inc. v. Elta Group Inc. [1998] O.J. 2910 (C.A.); Gestion Trans-Tek Inc. v. Shipment Systems Stategies Ltd. [2001] O.J. No. 4710 (S.C.J.).

There have been other creative responses to obtain shareholder liability.  For example garnishment was used to overcome a creditor proofing scheme.  Baskind v. Lauzen (1998), 43 B.L.R. (2d) 83 (Ont.Ct.Gen.Div.), (affirmed Ont.C.A. [1998] O.J. 623)

Additionally, there may be some developing law that will make shareholders liable if new corporations are so undercapitalized that they cannot perform what was promised, yet they took substantial up front payments.  Shillingford v. Dalbridge Group Inc., [1996] A.J. No. 1063 (Alta.Q.B.)

There is a serious limitation on the above approaches.  The plaintiff may not have evidence on any asset stripping.  In the months before a company is tanked financial records are not kept and original books and records get “lost”.  However, if the asset is cash, which is common, there may be records with the bank showing account statements with cancelled cheques.

The plaintiff’s counsel may have to risk a “shot in the dark” and allege asset stripping hoping to get supportive evidence through the litigation process relying only on the knowledge that asset stripping has become very common because it is very hard to catch.

On this point the August 2002 edition of C.F.O. Magazine reported that it had the bankruptcy records of top bankruptcies in the U.S. year to date examined.  In nearly every case the Magazine reported that millions were taken from “insolvent” companies and converted to directors’ offices and shareholders by dubious means.

The law governing piercing the corporate veil is in a muddle.  Purists allege that there is no such remedy, the phrase is merely a confusing metaphor.  Yet while it may be neigh impossible to pierce the corporate veil, it is often possible to skirt it.

Jan D. Weir practices civil litigation in Toronto with a focus on shareholder disputes and business valuation issues.  For reprints of this  and  previous articles see www.jdweir.com