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Corporations - A Separate Legal Entity

In today's economy, many people use a corporation as the platform for operating their business.  One of the most important reasons for incorporating is to limit the legal liability of the shareholders for the corporation's obligations.  This is unlike a partnership or sole proprietorship, where the "owners" of the business have unlimited liability for the obligations of the business.  The issue of shareholder liability for the corporation's debts or actions rarely arises where the corporation's shares are widely held by many shareholders.  It does, however, arise frequently in private, closely held corporations where there are only a few shareholders who control and manage the company. 

The business corporation is created by statute, and is given a separate, legal existence similar to an individual with its own rights and liabilities.  The shareholders are separate from the corporation, and their liability is limited to the extent of their investment in the corporation.  The general rule is that if a corporation goes bankrupt, the shareholders' loss will only be their investment in the corporation's shares, plus any loans the shareholder may have provided to the corporation.  This is reinforced by section 43(1) of the Alberta Business Corporations Act, which states:  "The shareholders of a corporation are not, as shareholders, liable for any liability, act, or default of the corporation except [in particular circumstances specified in other named sections]." 

In a closely held private corporation, the shareholders are typically also the directors, officers, and managers of the corporation.  The importance of maintaining a distinction between the shareholder of a closely held corporation, who may transact business on behalf of the corporation as its manager, and the corporation itself, cannot be overstated.  Where there is little or no distinction between the corporation and the shareholder, both may be liable for the obligations of the corporation.

One of the most frequent mistakes made by a shareholder/manager of a small corporation is the failure to ensure that the persons they do business with are aware that the shareholder/manager is acting on behalf of a corporation.  This is part of maintaining the separate legal existence of the corporation.  To ensure that others are aware that they are contracting with a corporation, the full name of the corporation must be prominently and legibly displayed at the corporation's business premises and set forth in all advertisements, promotional literature, business cards, invoices, purchase orders, and other printed material used by the corporation or its business.  Agreements entered into by the corporation must indicate the corporation as the contracting party.  If the name of any person associated with the corporation is included in any such material, such person's representative capacity with the corporation must be clearly identified.  Failure to make this distinction can make the individual personally liable under the contract.  Proper formalities for the execution of documents by the corporation's officers must also be followed. 

In addition, all money received and paid by the corporation must be done through the corporation's own bank accounts.  Mixing of the corporation's funds with those of a shareholder can defeat the limited liability protection afforded to the shareholder. 

Maintaining a distinction between a closely held corporation and its shareholders is only one aspect of ensuring the limited liability of the shareholders, and the foregoing are only a few examples of maintaining that distinction.  There are a number of other circumstances in which the distinction between corporation and shareholder could be blurred, thereby rendering the shareholder of the closely held corporation liable for acts or obligations of that corporation.  To ensure that the limited liability protection of shareholders is not affected, it is highly recommended that professional legal advice be obtained in any circumstances where the issue of potential shareholder liability may arise. 

By Tom Langford
February 20, 2002