Considerations in winding up a business

Sole proprietorship vs. a corporation

When a business is operated as a sole proprietorship, there is no legal distinction between the business and the individual owner. This results in the financial obligations becoming the sole responsibility of the owner. Therefore, an owner’s personal assets could be at risk if the business runs into financial difficulty, and a consumer restructuring, such as a consumer proposal or bankruptcy, may be required to deal with business debts. 

A corporation separates the owner from the business and defines the business as its own legal entity. The ownership of the company is divided into shares, and owners (shareholders) are not personally liable for the corporation's debts unless the debts are personally guaranteed or subject to directors’ liability through legislation. As a separate legal entity, a corporation would have additional restructuring options available, including a restructuring proposal or corporate bankruptcy, to deal with company debts. 

Options to wind up a corporation

There are two ways to wind up a corporation: 1) dissolving it or 2) bankrupting it.

1. Dissolution of a corporation

A corporation can be dissolved under the act in which it was incorporated, such as the Canada Business Corporations Act if the corporation is federally incorporated, or a similar provincial legislation, such as the Business Corporations Act in British Columbia, the Corporations Act in Ontario, or the Nova Scotia Companies Act if the corporation is provincially incorporated.

Dissolving a corporation means completing the legal steps to end the life of the legal entity. This is typically performed by filing articles of dissolution under the act in question; however, a key prerequisite to utilizing this method is that the corporation must be able to settle all its debts and obligations and hold no assets before winding up. If the corporation is unable to settle all of its debts, or is otherwise insolvent, the only official way of winding up a corporation is through a bankruptcy under the Bankruptcy and Insolvency Act. A corporation is insolvent if it is unable to pay its debts or obligations as they become due, or if the company’s debts exceed the value of the company’s assets, at a fair valuation or if disposed of at a fairly conducted sale. An insolvent company may be forced to wind up as creditors could take legal action against the company to recover debts owed.

2. Bankruptcy of a corporation

A corporate bankruptcy is a legal process that provides protection from creditors and creates a plan to liquidate assets, the proceeds of which are used to back the debts of the business. The corporation’s assets would vest to a Licensed Insolvency Trustee (LIT), an officer of the court appointed to administer the bankruptcy estate, who would develop a realization process with the input of the company’s creditors and distribute the proceeds based on the hierarchy of creditor claims.  

In summary, winding up a business through a corporate bankruptcy has the following advantages:  

• It takes the pressure and responsibility of administering the wind-down away from the business owners/directors.
• It provides for an orderly liquidation of the company’s assets through a public and transparent realization process.
• It allows for an orderly determination of creditors’ claims and a distribution according to the hierarchy of debts.

Avoiding pitfalls through professional advice

Owners of an insolvent corporation attempting to go it alone in selling assets and paying debts in order to wind up the business can run into multiple issues that may result in legal disputes and personal liability. For example, professional advice is often required to determine the hierarchy of debts or priority status of creditors depending on security agreements and legislation, and if any personal liability applies. If certain assets are sold and the proceeds are used to pay the wrong creditor, the owners/directors may be personally liable to the creditor with priority. 

To discuss the specific financial situation of your business and the options that may be available for business wind-down, contact a BDO Licensed Insolvency Trustee in your region today.