Creditor Proofing – Protecting Personal Assets from a Business Failure.
The advice that we give here is easy to put into place and will offer protection for personal assets in the case of a business failure. Taken to an extreme, one could creditor proof to the point where one can’t borrow funds to operate a business! Be practical when designing a creditor proofing plan.
The time to put a creditor proofing plan in place is at the commencement of the business – not at the time of the business failure.
- Get professional legal and accounting advice before the business commences. This is the time to put a creditor proofing plan in place. Incorporation not only has income tax benefits, but also provides for a level of creditor protection.
- Consider incorporating if the size of the business warrants or the nature of the business is litigious.
- Only one spouse should be a director or officer. The other can be still be a shareholder or employee, but should not be a director or officer. This should minimize the risk of joint and several directors’ liability for certain statutory debts.
- Always pay statutory debt on time (source deductions, GST, HST, wages and PST). Directors and officers can be personally responsible for these debts.
- Don’t have significant assets in your personal name. If possible, consider having assets in a spouse’s name or a family trust. One should be cautious of the Family Relations Act when placing assets in the name of a spouse.
- Do not give a personal guarantee to suppliers or a landlord unless it is absolutely necessary. Do not give your spouse’s guarantee to a lender. Simply state “a personal guarantee is not available”. The results are surprising!
- Have only the corporation borrow funds from the bank. Don’t let the bank lend the funds to a client personally with the client then lending the funds to the company. This will ensure the bank is the first person paid in the event of a liquidation of a business. This will continue to apply even if personal security is required for the loan.
- If a family member or a principal of a company lends money to a company, have that person take back security. Ensure proper documents are prepared and register the security. If the loan is not documented and registered, a trustee may be able to recover any preferential payments made to the family member or principal (payments within a year of the bankruptcy could be considered fraudulent preferences under the Bankruptcy and Insolvency Act).
- Invest in RRSP’s or other vehicles that are “judgement proof”. If the worst happens you still have retirement funds.
- Be cautious of rapid business expansion. Recognize the risks of expansion as well as the opportunities. Many businesses fail because they under bid a job, expanded too quickly, or did not have the resources to finish a project.
- Plan for succession well in advance. A successful business requires a successor.
- If the business incurs financial difficulty, seek professional advice early. Many businesses wait too long – early advice may have saved them. Proposals to creditors made under the Bankruptcy and Insolvency Act are very effective and usually accepted.
- Know when to quit. If a business is in financial difficulty, decide on the amount of personal funds that will be expended to attempt to save it.
Remember, put the creditor proofing plan in place at the commencement of the business – a creditor proofing plan rarely works when the business is in trouble.
- Be loyal to secured and statutory creditors.
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