A frequent cause of personal financial difficulties is that the failure of a business and the attendant business-related obligations personally owed by the business owner. These people must often file for bankruptcy or make a proposal to their creditors due to business-related debts.
Debtors finishing their insolvency / proposal often want to begin another business sometime in the not too distant future. The anticipated question then arises: how do they creditor-proof themselves in the event that their new business fails? Here are some ideas:
1.) Consider integrating the business. Incorporation will offer the owner with a degree of creditor protection – most of a company’s duties are limited to its assets so this arrangement provides protection for personal assets. This arrangement also has income tax benefits, which won’t be discussed here, (this topic warrants its own article which is published at a later date).
2.) Always pay statutory debt on time, especially:
* Payroll source deductions;
* Goods and Services Tax collected;
* Provincial Sale Tax gathered;
* and Employee wages and vacation payable.
In Ontario (and in some other provinces), company directors can be personally responsible for these debts, notwithstanding that the business is incorporated.
3.) If the owner is using their own funds to invest in the business, it’s a good idea to do this in the form of a loan to the company secured by a charge over the assets. An attorney should ensure that the appropriate documents are ready and the security interest is properly registered. In the event the company fails, the security interest will have a priority over all unsecured creditors with regard to realizing
If the loan isn’t properly registered and documented, the owner may become an unsecured creditor waiting in line to be paid with the rest of the creditors in the event of business failure.
4.) Consider acquiring personal assets in a spouse’s name or a family trust. Such assets don’t form part of the transferor’s bankruptcy estate and are therefore not subject to claims of estate lenders.
5.) If the business owner is putting away money for retirement, consideration ought to be given to investing in RRSPs which are exempt from claims; for instance, segregated funds. The differentiation between segregated funds and mutual funds is that segregated funds are insurance contracts. The Ontario Insurance Act provides that:
“in which the beneficiary of this Insurance coverage is a partner, child, grandchild or parent of someone whose life is insured… the rights and interests of the insured in the insurance money and in the contract are exempt from execution or seizure…”
Consequently, insurance products held in RRSPs will be exempt from seizure by creditors.
6.) If you can avoid doing this, personal guarantees of a business obligation shouldn’t be given to providers or a landlord unless it’s absolutely essential.
With some foresight (what is the worst that can happen, and how do I avoid it?) And careful planning with all the applicable initiatives outlined above, an individual can create a productive creditor-proofing strategy that will allow the business owner to ready herself or him if things do not go as well as anticipated.
Creditor proofing is best undertaken at the beginning of a business enterprise – if there are only a few resources and no claims outstanding. From the time a claim occurs, it might be too late to move resources beyond the reach of creditors.