Directors may be personally liable for stripping value to defeat creditors

Where an individual is both a corporate director and a shareholder, can they be held personally liable for stripping value from a corporation to defeat corporate creditors? “Yes”, according to the Court of Appeal for Ontario’s recent decision in FNF Enterprises Inc. v. Wag and Train Inc, 2023 ONCA 92. But what is the legal basis for imposing personal liability for the corporation’s obligations? In this case, the Court of Appeal (the Court) allowed an oppression claim to proceed against the director for depleting corporate assets to avoid liability arising from a broken lease, but it did not green light a claim against her as a shareholder based on corporate veil-piercing. This decision adds to the Court’s recent law on the limits of corporate form, clarifying the distinction between piercing the corporate veil and holding directors personally liable under the oppression remedy.

What you need to know

• Directors may be held personally liable for value stripping. A director who is also a shareholder cannot take assets in priority to, and to the prejudice of, unpaid creditors. The Court held that creditors may pursue an oppression claim personally against a director for misusing their corporate powers in this manner.
• No reason to pierce corporate veil. Causing a corporation to breach a contract (here, a lease) and stripping value from the corporation to avoid obligations under that contract are not grounds to pierce the corporate veil. Because the corporation entered the lease for a valid business purpose, it would be inappropriate to pierce the corporate veil to shift the liability from the lease onto the individual as a shareholder.

Background: motion judge strikes claims against director

In 2015, Wag and Train Inc. (WT)—a company with a sole director, officer and shareholder—leased a commercial premise. The lease was set to expire in March 2021. About a year before the lease expired, WT abandoned the property and stopped paying rent. The defendant, the director/shareholder, allegedly stripped assets from WT and recommenced her business under a new corporation in a new leased premise.

The landlord commenced a claim against WT and its director/shareholder seeking to hold her personally responsible. The claim alleged two bases for imposing personal liability under the lease: (i) the defendant conducted herself in a manner that justified piercing the corporate veil and holding her responsible as a shareholder to the landlord; and (ii) relief against the director personally for the corporation’s lease obligation was warranted under the oppression remedy in section 248 of the Business Corporations Act (Ontario).

A motion judge struck the claims, concluding that, where a complaint concerns a breach of contract, a contract action against the corporation is the appropriate remedy. The landlord appealed.

Court of Appeal allows claim against director to continue

The Court overturned the motion decision in part. It held that, although there was no basis to pierce the corporate veil and hold the defendant liable as a shareholder, the claim could continue under the oppression remedy against the defendant as a director:

• Corporate veil not pierced. Courts “disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct”. Here, that test was not met. Corporate veil piercing requires that fraudulent or improper conduct be the source of the liabilities that the plaintiff seeks to remedy, and here, the source of the liability was a lease entered into for valid business purposes.
• Oppression remedy may apply. The lease may have been entered into for legitimate reasons, but the director’s decision to dissipate corporate assets to avoid the lease was not. The oppression remedy is available to address corporate conduct that defeats the reasonable expectations of corporate creditors as a class of corporate stakeholders eligible to use the oppression remedy, and in the right cases, a remedy may be made against a director. Creditors can reasonably expect that directors will comply with their statutory duties not to divert corporate assets in priority to, and to the prejudice of, unpaid creditors.

As a result, the Court permitted the claim against the director under the oppression remedy to continue. The Court held that personal liability against the director may be appropriate because the director was alleged to have taken the oppressive steps for her own benefit to the detriment of the corporation’s creditors.

Implications: corporate form remains, but remedy still available

While the outcome of the case means that the individual defendant may ultimately be liable to the landlord, the basis for that potential liability reinforces the principle of corporate separateness. As shareholder, the defendant is not responsible for the corporation’s obligations, but as director, she may be held liable on the basis that she caused the corporation to act oppressively and for her own benefit. The oppression remedy may provide personal recourse against directors who act contrary to their duties and place their own self-interest above the corporation’s stakeholders. Directors must consider broader stakeholder interests, including those of creditors, when making decisions that will affect those stakeholders. However, protection for those stakeholders needn’t undermine the fundamental principle of corporate separateness. In the case of a sole shareholder corporation such as WT, the distinction may not ultimately matter; in a corporation with a broader shareholder base, it would.