Whether you’ve built your own business from the ground up or have been tasked with taking over the long-time family business, it would be prudent to ensure the hard-earned assets contained in your business are protected as much as possible from third parties, namely creditors. Creditor proofing for a business owner means protecting significant business assets from exposure to potential future creditors – that is, from persons who may have legal rights against the business and its property for various reasons (e.g., for money owed). Although the law in Ontario generally prohibits creditor-proofing techniques performed with improper intent, such as those that hinder or impair the rights of existing creditors, it is perfectly acceptable (and highly recommended) to organize your business’ affairs in a way that reduces the risk of the business’ property becoming vulnerable to the claims of future creditors. There are numerous methods of structuring your business to minimize creditor risk that can and should be implemented to safeguard your business’ assets.
One of the most common creditor-proofing techniques involves making a shareholder loan to your corporation. The owners of the business – those who hold shares of the corporation – can loan a sum of money to the corporation and secure their investment by way of a general security agreement (“GSA”) and registration in the Personal Property Security Registry. As the outstanding balance of shareholder loan accounts can change frequently due to fluctuating capital requirements in the business and/or due to tax planning, the GSA should be carefully crafted to ensure that the obligations secured is defined as broadly as possible. These secured shareholders/owners would then rank in priority to subsequent creditors of the business.
The use of separate corporations to segregate and insulate the assets associated with one business from the risks associated with the other business is also a common asset protection technique, since having two separate corporations would mean separate liabilities. This is akin to diversifying your investments or not “putting all your eggs in one basket”. For example, if your operating company (“OpCo”) already owns real estate, it may be beneficial to transfer such asset to a holding company (“HoldCo”) on a tax-deferred basis via a tax rollover or corporate re-organization. Not only would this segregation protect such real estate from the creditors of OpCo, your HoldCo could charge OpCo rent for OpCo’s use of such real estate, which can result in favourable tax benefits.
Having separate corporations to hold the assets of the business can also provide for a safeguard against creditors by means of intercompany secured loans. For example, if your OpCo requires more funds to manage the day-to-day operations of the business, your HoldCo can loan the required sum to OpCo and secure its loan via a GSA and registration of a financing statement under the Personal Property Security Act (PPSA) against all of OpCo’s assets. As a result, in the event of OpCo’s bankruptcy or liability to a future creditor of OpCo, your HoldCo can realize on its loan (i.e., enforce its PPSA security), allowing it to claim OpCo’s assets in priority to any unsecured or subsequently secured creditors.
As a variation to the above example, if transferring the real estate asset owned by OpCo to HoldCo would trigger substantial land transfer tax, it may instead be worthwhile to consider fortifying such real estate from OpCo creditors by giving HoldCo a mortgage against such real estate in exchange for a loan advanced. The mortgage security would be enforced when such real estate became entangled in a claim by one of OpCo’s creditors, ensuring that this asset is sheltered and out of reach from such third-party creditors.
The above techniques are only some of many that can be utilized by business owners to protect their assets from creditors and limit their business’ liability. Other methods can involve the use of trusts, insurance, RRSPs and RRIFs. However, any creditor protection plan is subject to scrutiny and potential challenge from parties like secured creditors, preferred creditors, Canada Revenue Agency, provincial revenue authorities, trade creditors, suppliers and employees. As such, you should always consult a lawyer competent in corporate law as well as an accountant when creating such plans. Creditor proofing can be a complicated and highly technical process, but when done correctly, it can be a powerful and essential risk management tool for you and your business.