It is a well-established legal principle that a company and its shareholders and directors are separate entities, with separate liabilities. However, especially with small businesses, the actions and decisions of the company are essentially those of the shareholders and directors. Should they be personally liable when making possibly imprudent decisions?

In a recent decision, Chenail fruits et légumes inc. c. Produce Town Inc., the Quebec Superior Court maintained the distinction between the liability of a company and that of its director when the company faces financial difficulties.

The Court found that attributing liability to directors would have a negative im- pact on their behaviour by de- incentivizing any attempt to revive a company’s fortunes when faced with insolvency. As such, a director will not be held liable simply for having failed to announce to a creditor the negative state of the company’s financial affairs. To be held liable, a director must know that insolvency is inevitable, and carry on business despite this knowledge.

The facts

Chenail fruits et légumes [“Chenail”], a produce supplier, sought recourse against Produce Town, an Ontario- based company specialising in the sale of produce, and Brent Ramsay, the com- pany’s shareholder, director and president.

Produce Town had been experiencing financial difficulties: it had exceeded its credit limit with its bank and was in de- fault with several of its creditors, includ- ing Chenail.

Produce Town’s liability was never at issue: instead, the judgment concentrat- ed on Ramsay’s personal liability as its director.

Chenail claimed that Ramsay had failed to inform it of the cancellation of its line of credit, or of pending lawsuits under- taken by Produce Town’s other credi- tors. At no point, however, was it al- leged that Ramsay had acted unlawfully in his dealings with Chenail, and Pro- duce Town had always been the party that stood to gain from his actions as director.

The decision

The Court considered the following grounds raised by the plaintiff:

  • Piercing the corporate veil. As this is an exceptional measure, a Court will only do so in clear cases of abuse. In this case, Chenail had been dealing with Produce Town for years. There was no allegation that Produce Town’s activity was illegitimate or that transactions were not carried out in its interest. Chenail knew that Pro- duce Town was the debtor and that recovery of the amounts owed de- pended on its solvency. Had Chenail wanted Ramsay to be personally liable for the company’s obligations, it would have asked for a personal guarantee (which was alleged in this case, but not proven). Chenail cannot achieve this result by piercing the corporate veil, especially when the de- fendant is a minority shareholder, as was Ramsay.
  • Mandate. An agent can be held per- sonally liable when he knowingly rep- resents an insolvent principal. Howev- er, the courts have repeatedly held that this rule only applies to undis- closed mandates, which is not the case here, as Ramsay had always been above board about his status.
  • Extra-contractual liability. Chenail argued that failure to disclose Pro- duce Town’s financial difficulties was, by itself, an offence for which Ramsay was personally liable. This possibility was dismissed, as Ramsay had always been straightforward and made legiti- mate efforts to enable the company to honour its obligations.