What happens to a business when a shareholder goes bankrupt?

Self-employed people are among those who sometimes get into debt trouble and need to file an assignment in bankruptcy or make a proposal to their creditors. Sometimes the cause for their debt problems is the business itself and other times the causes are entirely unrelated. But it always creates questions and sometimes concerns for anyone who has an interest in the business.

The company is probably fine, unless it’s the problem

Owners of corporations can generally file a personal bankruptcy without affecting the corporation. The shareholder and the corporation are two separate entities. I like to give the example, “if you were the owner of shares in the Royal Bank of Canada and you went bankrupt, would you expect RBC to be affected?”

If you file a personal bankruptcy, you might need to resign as a director of your corporation, but that doesn’t limit you from continuing to own the shares.

Sometimes, the more important question is “should I continue my business”?

Sometimes, the more important question is “should I continue my business”? If the business is the cause for your debt problems, you should take a hard look at whether the debts of the corporation should be restructured or if the corporation should be abandoned.

For most small businesses, banks lend to corporations based (at least in part) on the strength of its shareholders. More often than not, if the corporation is in good standing, the lender will be happy to continue to lend to the company. On rare occasions, a lender may insist that the shareholder sign a new guarantee after the date of their personal bankruptcy, effectively re-instating it. Rarer still, if a lender to the corporation suddenly feels that its underlying guarantee from the shareholder has been compromised, the lender may exercise its rights to demand payment from the corporation.

How will my company affect my bankruptcy?

Your shares in the corporation will vest with the Trustee in Bankruptcy, once your bankruptcy is filed, which means your assets become property of the bankruptcy estate and the trustee must sell - generally the Trustee will sell them bank to you because, more than likely, your trustee will not wish to operate your business.

Instead, the trustee will calculate a present value of the shares of the corporation and you will be required to pay to your bankruptcy estate the value of your shares, based on this calculation. If the shares are deemed to have no value because the company’s debts outweigh its assets, your trustee will take no action against them and release them back to you.

What debts of the company will be included in my personal bankruptcy?

If the company stops operating, your personal bankruptcy will release you from your responsibility for any personal guarantees you have provided

The company debts that will be included will depend on whether the company continues to operate after you file a personal bankruptcy.

If the company continues to operate it is still responsible for all of its debts, even if you file a personal bankruptcy. Your personal liability relating to company debts for which you provided a personal guarantee or directors’ liability debts (HST and payroll deductions) will be limited to the amount of these debts on the date of your bankruptcy.

If the company stops operating, your personal bankruptcy will release you from your responsibility for any personal guarantees you have provided to creditors of the company as well as any director’s liability obligations for unpaid HST and payroll deductions.

What happens to my corporation if I choose to walk away from it?

If your business is the cause of your personal debt problems and the company is not worth salvaging, you may choose to walk away from the company. Assets with liens or mortgages will be seized and sold by the creditor with the lien.

The protection that you will enjoy in your personal bankruptcy will not extend to the company and its creditors

In the interim, your first order of business will be to resign as director. If you have the resources and the information necessary, you should file outstanding HST and payroll returns and shut down those accounts as a housekeeping matter and to mitigate telephone calls from Canada Revenue Agency.

The protection that you will enjoy in your personal bankruptcy will not extend to the company and its creditors. When dealing with the creditors of the company, you should tell them that the company is closed, that you have filed a personal bankruptcy and you no longer work there, and that the creditor can take legal action to collect the debt from the company.

None of this is fun but handling these matters with eyes wide open is important. If you’re looking for a reset so you can start fresh with a clean slate, understanding these matters and dealing with them appropriately is necessary. An LIT (Licensed Insolvency Trustee) can help you make these important moves.