Think back 4 years ago. Before 9/11, SARS, Mad Cow Disease, Avian Flu, Enron, Worldcom, Pine Beetles, Softwood Lumber Duties ….. The world has forever changed. Risk is now a way of life. The impact on our personal lives and businesses has been immense. Given the unprecedented level of uncertainty we all live with, we still find that most small business owners have taken little if any action to protect themselves.
This article will look at the issue of protecting business and personal assets from the unforeseen claims of creditors. We will begin by examining the sources of the risk and then look at strategies, including life insurance programs, which can be undertaken to reduce the exposure.
A. The Sources of Risk
Generally speaking, risk comes from two sources: Business and financial.
Business risk includes the normal liability exposure of running a business. This can vary widely depending on the nature of the business. For example, a doctor may have a much higher degree of business risk than someone who runs a shoe repair business. One thing is certain, wherever the business falls within the risk spectrum, the potential for a liability claim has increased dramatically in the last several years. This by virtue of an increasingly litigious society and judges who are much more inclined to award large settlements based on the motivation of compensating the victim as opposed any one being at fault. A second aspect of business risk relates to items such as business interruption and loss of profits because of unforeseen events. Examples include items such as fire, natural disasters and items mentioned previously (softwood lumber duties, SARS, pine beetles and Mad Cow disease).
Financial risk would encompass all forms of indebtedness to third parties. This includes loans, secured charges, personal guarantees, trade payables and of course amounts owing to the Canada Revenue Agency (“the CRA”).
If someone is operating as a sole proprietor or through a partnership, the liability is unlimited for both business and financial risk. Everything is on the line. However, many people are of the view that operating through a limited liability company shields them from risk. Although at one time there may have been some validity to this, the reality is that in the modern business environment running a business through a limited liability company offers minimal protection. There are several reasons for this:
As a final matter it should be mentioned that while most business owners have liability and hazard insurance protection, the value of this has diminished considerably in recent years. Coverages have become increasingly restrictive, exclusions broader and deductibles (and premiums) have become much higher.
B. Planning Options
These generally fall into two categories: 1. Transferring assets out of the company; and 2. Securitizing the position of the business owner.
Transferring assets out of the company – A creditor can only attach what you own. To the extent an operating company does not own anything, there is nothing to go after. Here are some strategies for transferring assets out of a company (we will assume throughout this article that any transfers will be done in such a manner so as to avoid application of provincial Fraudulent Conveyance legislation).
Securitizing the position of the business owner – The remainder of this article will look at various strategies for securing the position of the business owner (by transferring assets to other parties or placing assets into creditor protected vehicles) while still allowing the business owner to enjoy some degree of control and benefit.
The risks of carrying on business in the 21st century are substantial and expanding. The thinking of most advisors and wealthy families has not caught up with this reality. Numerous strategies and planning opportunities are available to protect the family wealth. It is a case of use it or risk losing it.
1. RSC 1985 c. C – 44
2. Examples include the Income Tax Act: Goods and Services Tax Act; Environmental Protection legislations and Workers Compensation legislation.
3. We will assume throughout this article that any transfers will be done in such a manner so as to avoid application of provincial Fraudulent Conveyance legislation.
4. Section 186 of the Income Tax Act Canada R.S.C 1985, c. 1.
5. Defined in Section 248(1) of the Act (Kevin: you may wish to include references to previous Articles in Insurance Planning – I do not have a comprehensive index).
6. Not specifically dealt with in the Act. However, see Interpretation Bulletin IT 85 R2.
7. Section 125 of the Act.
8. Section 73(1) of the Act.
9. Kevin – please include reference to earlier articles in Insurance Planning which deal generally with estate freezing.
10. The definition of “disposition” in Section 54 of the Act includes a transfer of property to a trust. Section 73 (1) of the Act deals with “alter-ego” and “joint partner” trusts. (Kevin, please also include reference to the previous article which I published in Insurance Planning on Joint Partner and Alter Ego trusts.).
11. See for example Insurance Act of British Columbia RSBC 1996 Chapter 227.
12. Kevin – I couldn’t lay my hands on the Ramgotra citation. If you have it handy, please insert. Otherwise, let me know and I will dig further. Thanks.
13. Kevin – again, I think we can refer to previous articles in Insurance Planning.