Small business safeguards
Understanding the importance of having a creditor protection strategy.
The Canadian economy is fuelled by the enthusiastic hard work of the small business owner. The Business Development Bank of Canada estimates that 70 per cent of the country’s private labour force is employed by small businesses, and the diversity is amazing – from make-your-own jewellery storefronts to microbrew pubs to the dental clinic in your neighbourhood.
A small business venture may be a deeply personal dream come true, but even dreams don’t always work out. Surprisingly, many owners, officers and directors don’t realize their personal assets can be at risk of creditor claims in the event that something goes wrong with the business. The coronavirus pandemic is certainly a challenging time, and it points to the importance of having a solid creditor protection strategy to help minimize the impact in the event your venture doesn’t continue to flourish.
Make your business creditor-proof
The best time to implement a creditor-proofing strategy is either when the business is starting up or while it is healthy and not facing creditor claims. It’s almost impossible to establish a creditor protection plan when a business is in trouble. Tax and legal professionals, with the assistance of your advisor, can help you in developing a plan that covers all the bases. The following tips can help to serve as a guide in the process:
Think about incorporating your business if it is either large or at risk of litigation. Professional practices should carefully consider this option.
Not all debt is created equal. Always pay your statutory debt on time; directors and officers can be personally liable for these debts (see A note on liability below).
Ensure sufficient personal liability coverage (e.g., director’s home and auto coverage). In the event of a serious accident, your personal assets (e.g., home, car, boat) could be seized to pay any shortfall in insurance coverage.
Ensure that your spouse is outside the reach of creditors in the event that anything goes wrong in the business. If your spouse is a director or officer, they can carry liability for debts. If your spouse is an employee, or not involved in the business, you will have much more flexibility in your creditor protection plan.
Make use of spousal Registered Retirement Savings Plans (RRSPs) to transfer wealth to a spouse – and away from creditor risk.
If your spouse is not involved in the business, consider moving your personal assets – such as your house and your savings – to your spouse’s name. You can transfer home ownership to your spouse tax-free.
Hold life insurance contracts personally (not corporately). Name a “family class” beneficiary on life insurance contracts and list yourself as both the owner and the annuitant/insured. Doing so may prevent creditors from seizing the assets, as well as ensuring the assets transfer immediately to your beneficiary at the time of your death. Remember that if the death benefit is payable to your estate, it can get tied up in probate and may be subject to fees and seizure by creditors of your estate.
Place your savings into investment products sold by insurance companies. A segregated fund contract or a Guaranteed Interest Contract (GIC) product purchased through an insurance company offers potential creditor protection when you name a “family class” or irrevocable beneficiary.
Hoping for the best while preparing for the worst is just good planning if you are a business owner. You are investing a great deal financially, emotionally and physically to create a successful venture. Your advisor can help you to create a plan that will protect your hard-earned assets from creditors.
What is a “family class” beneficiary?
A family class designation is a spouse, child, grandchild or parent of the annuitant in all provinces except Quebec. In Quebec, a family class designation includes the spouse, ascendants and descendants of the policy owner.
Be cautious about naming an irrevocable beneficiary
Your rights as an owner become limited. Without the consent of the person you’ve named as irrevocable beneficiary, you can’t:
Change the beneficiary
Change the ownership
Cash in the policy
Assign the policy as collateral for a loan
Naming a child as irrevocable beneficiary on an insurance contract, including an investment contract, means that the contract is effectively frozen until the child is grown – because children cannot legally give consent until they have reached the age of majority.
A note on liability
Business owners, officers and directors can be personally liable for:
Any debts they have given a personal guarantee
Any statutory debts, such as wages and vacation pay
Any source deductions and commodity taxes
Health and safety violations, including environmental damage