By: Scott McEachern
Unlike major corporations, most small businesses are owned and operated by the shareholders. Indeed, in many incorporated small businesses the shareholders are the officers, directors, and employees.
For a variety of reasons, including limiting personal liability risks, which can be reviewed with, assessed by, and advised upon, by a corporate law lawyer, a small business operator may wish to incorporate the small business. Unfortunately, many owners of a small business will incorporate the business with the goal of avoiding personal liability risks while misperceiving that personal liability risk is absolutely eliminated by incorporation rather than merely limited by incorporation. This article should help to demystify where personal liability risk remains and where personal liability risk becomes shielded via incorporation.
Firstly, this article is written in the context of providing information relating to the 'targetability' of an officer or director within litigation; such as and for example, the plumber who owns and operates a small, incorporated, plumbing business and is sued in Small Claims Court for negligent performance of workmanship, among other things. For information and explanation on when it is best to incorporate and how to incorporate, contact a lawyer that provides corporate law services. Additionally, this article is for general information purposes only rather than litigative advice. For advice, including case strategies, among other things, contact a lawyer or paralegal for a proper review of your unique circumstances.
Principle Exception, Said v. Butt
The starting point in any discussion on where personal liability risk for a director of a corporation starts with an understanding of the Said v. Butt exception and general tort law principles, particularly 'business torts'. For legal practitioners without a strong foundational knowledge of 'business torts', obtaining mentorship or co-counsel may be prudent prior to taking on litigation alleging 'business torts' and involving directors or officers or employees personally named as defendants.
According to the Court of Appeal per ADGA Systems International v. Valcom Ltd., 1999 CanLII 1527, when the decision to breach a contract is made by a director or officer (or an employee authorized to do so by a director or officer) who is acting as the 'controlling mind of the corporation', and the decision is made in good faith without ulterior motive such as a personal benefit to the director or officer and where it is deemed that the corporation is better off paying damages for breach rather than paying for the cost of performing the contractual obligations, the director or officer is given a 'free pass' from any personal liability. Essentially, whereas a corporation is unable to think and decide absent of a human being, the human being, whether director or officer (or employee given proper authority) is protected from the risk of personal liability that may arise from the making of the decision to breach. Of course, the corporation itself may be liable for the breach but the human who made the decision on behalf of the corporation is protected. This arises from the Said v. Butt exception to the general tort law principle that intentionally interfering in contractual relations is itself a tortious wrongdoing. Per ADGA:
"... a claim may be asserted for the tortious conduct of individuals where the defence in Said v. Butt is not available."
The reasoning within ADGA was provided by Carthy JA while citing McCardie J from the Said v Butt decision as:
I hold that if a servant acting bona fide within the scope of his authority procures or causes the breach of a contract between his employer and a third person, he does not thereby become liable to an action of tort at the suit of the person whose contract has thereby been broken. . . . Nothing that I have said to-day is, I hope, inconsistent with the rule that a director or a servant who actually takes part in or actually authorizes such torts as assault, trespass to property, nuisance, or the like may be liable in damages as a joint participant in one of such recognized heads of tortious wrong.
Accordingly, the personal liability protection granted to directors and officers as human individuals per the ADGA decision clearly states that such protection is limited to the Said v. Butt exception and that legal claims for other tortious conduct is fair game. Whereas the above appears to clearly show that the ony exception for potential tort liability involves limited protection arising from the 'inducing breach of contract' tort, it is confusing as to why many legal practitioners, and even members of the judiciary, perceive that additional forms of tortious conduct are protected under a 'corporate veil'. Perhaps the misunderstanding arises whereas, per Carthy JA in ADGA citing Said v. Butt it was stated that, "... such torts as assault, trespass to property, nuisance, or the like ...", may remain actionable; however, this non-exhaustive list is often perceived, and treated, as exhaustive. The, "... or the like ..." aspect of what was said, somehow, becomes lost or forgotten. Incredulously, of the, "... or the like ..." torts that become commonly forgotten is negligence. Some legal practitioners will argue that ADGA suggests that the protection fails to exist for intentional torts such as assault; however, what is lost is that trespass to property and nuisance are strict liability torts that can arise innocently and are therefore torts even 'softer' than negligence. It is illogical that the Court of Appeal would suggest in ADGA that an intentional tort such as assault and innocent but strict liability torts such as trespass and nuisance are actionable while middle ground torts such as negligence remain protected by some sort of a corporate veil. Such an interpretation of the "... or the like ..." torts would allow for liability against directors and officers for intentional torts and innocent but strict liability torts while exempting liability for the middle ground torts such as negligence and thus such an interpretation lacks common sense. While it makes sense that personal liability as a hardship should arise for participation in an intentional tort, it makes little sense that personal liability as a hardhip would arise for innocent but strict liability conduct while exempting the middle-ground from personal liability.
As an example of the absurdity of such an interpretation, imagine a situation where Joe the plumber is the owner, director, shareholder, and employee, of Joe's Plumbing Inc. Bob, a homeowner, enters into a contract with Joe's Plumbing Inc. The contract is for the repair of a leaky kitchen faucet. Joe's Plumbing Inc., being merely a corporation via 'piece of paper' must send Joe, a human being, out to do the actual work of repairing the leaky faucet. While Joe is doing the work an argument ensues with Bob. The argument arises where Joe accidentally, but negligently, overtightens a plumbing connection causing water to spray onto, and damage, a hardwood floor. Seeing the damaged hardwood, Bob yells at Joe. Joe then stands up, punches Bob, smashes a Ming vase, and walks out the door leaving a tool box behind. Subsequently Bob sues Joe's Plumbing Inc. for breach of contract, among other things, but also names Joe personally in the lawsuit and makes claims for assault, negligence, and nuisance, as against Joe. In this example, how much sense would it make if the, "... or the like ..." mentioned in ADGA was actually interpreted so to omit negligent acts? If ADGA actually intended omission of negligence (and therefore protection from personal liability arising out of negligence), the personal liability of Joe for the incident involving Bob would arise for the punch to the face (assault) and the leaving a tool box behind (nuisance) but the poor repair work (negligence) resulting in the damaged floor would receive a 'free pass' being protected by some 'corporate veil'. This interpretation and operation of the law would yield absurdity.
A further absurdity would arise when Joe submits the lawsuit to the general liability insurance carrier for Joe's Plumbing Inc. whereas general liability policies protect against unintentional injury or damage arising from the operations of the business with an extention of the coverage so to provide liability protection to directors and officers and employees for negligent acts occurring during the course of rendering services on behalf of the corporation. If ADGA truly stood for the point of law that directors and officers were to receive personal liability protection for negligent acts, then ADGA would be stating that the liability for negligence coverage granted in general liability policies is moot and pointless - thereby making every insurer and every insurance broker in the country that provides commercial insurance services potentially at risk of misrepresentation allegations and potentially even criminal fraud charges due to the public offering of a 'moot' insurance coverage.
As a legal advisor, when handling cases where a director or officer is personal included in the litigation, when asked if personal liability can actually arise or whether the 'corporate veil' guarantees protection, I typically advise by simply stating, "If you were the person that negligently swung the hammer that bent the nail, then you can be, and likely will be, found personally liable for bending the nail. Just because the contract was with your corporation you don't get a 'free pass' from liability arising out of your own negligence". Of course, the above comment is metaphoric whereas the issue always involves something much more significant than just a bent nail; however, the overall point is usually well made.
Thankfully, after nearly two decades of misunderstanding and misinterpretation of the ADGA decision by legal practitioners, and even some lower court members of the judiciary, the Court of Appeal recently issued the Sataur v. Starbucks Coffee Canada Inc., 2017 ONCA 1017 decision. While the Sataur decision clearly states the an employee may be personally liable for negligence while acting on behalf of an employer, and does so without mentioning the same about directors or officers, the principles laid out in Sataur should plainly and obviously apply equally to directors and officers.
Further on the risks of personal liability for the small business owner who is commonly the shareholder, director, officer, and employee, perceiving that an absolute corporate veil protection for personal liability against negligence exists flies in the face of the Jean Jones v. Richard Neilson, 2014 ONSC 6795 decision wherein it was stated by the Divisional Court that:
[13 ] It was also open to the trial judge to find that the situation here fell within an exception to the general principle of the separate legal personality of a corporation. The trial judge made findings of improper conduct by Mr. Neilson. Those included, for example, the fact there were logos on the face of the contract, suggesting that the appellant corporation belonged to organizations that it was not, in fact, a member of. They also included the fact that the work had been undertaken without ensuring that the necessary building permit had been obtained. Based on those findings, and considering the evidence as a whole, it was open to the trial judge to conclude that to limit the respondent’s recovery only to the corporate appellant “would yield a result too flagrantly opposed to justice”. The trial judge could equally have concluded that the corporate appellant was dominated and controlled by Mr. Neilson and was being used by him as a shield for improper conduct, especially given her findings that the work done reflected shoddy workmanship and negligent design for which the respondent received no benefit.
The decision in Jean Jones clearly suggests that personal liability for negligent workmanship or negligent design, among other things, can arise. In the Jean Jones case, a number of issues came together to result in personal liability against the owner of the small business corporation. Such issues included misrepresentations and failure to comply with obligations to fulfill statutory requirements while also suggesting that personal liability could arise merely from the, "... shoddy workmanship ...".
Further, even if 'corporate veil protection' did exist despite hands-on negligence, the Supreme Court carved out a discretionary exception in Kosmopolous v. Constitution Insurance Company of Canada,  1 S.C.R. 2 at paragraph 12 where it was stated:
As a general rule a corporation is a legal entity distinct from its shareholders: Salomon v. Salomon & Co.,  A.C. 22 (H.L.) The law on when a court may disregard this principle by "lifting the corporate veil" and regarding the company as a mere "agent" or "puppet" of its controlling shareholder or parent corporation follows no consistent principle. The best that can be said is that the "separate entities" principle is not enforced when it would yield a result "too flagrantly opposed to justice, convenience or the interests of the Revenue": L. C. B. Gower, Modern Company Law (4th ed. 1979), at p. 112. I have no doubt that theoretically the veil could be lifted in this case to do justice, as was done in American Indemnity Co. v. Southern Missionary College, supra, cited by the Court of Appeal of Ontario. But a number of factors lead me to think it would be unwise to do so.
Further, in London Drugs Ltd. v. Kuehne & Nagel International Ltd.,  3 S.C.R. 299, which is cited in Sataur at paragraph 4, Justice McLachlin said:
It has always been accepted that a plaintiff has the right to sue the person who was negligent, regardless of whether the employee was working for someone else or not.
The above provides for just a few examples where personal liability can attach to the owners and directors and officers of an incorporated small business. Further examples, among many others, include the failure to properly hold out the existence of the corporation in advance to forming a contractual relationship as well as for 'unfair practices' involving breaches of statutory consumer protections.