Reducing Direct Liability of a Contractor via Incorporation

Contact Neufeld Legal PC for your incorporation legal work at 403-400-4092 or Chris@NeufeldLegal.com

Incorporation effectively limits an independent contractor's direct personal liability through the interposition of a separate legal entity - the corporation. The corporation is legally recognized as distinct legal person, separate from the individual contractor, such that the corporation is itself responsible for its own debts and obligations. This legally recognized separation is known as the "corporate veil."

Key Principles of Liability Protection

• Separate Legal Entity: Once you incorporate, your business becomes a separate legal entity from you as an individual. This means the corporation can own property, enter into contracts, and incur debt in its own name. The corporation is liable for its own actions and financial obligations.

• Protection of Personal Assets: As a contractor operating a corporation, your personal assets—such as your home, car, and savings—are generally protected from business-related lawsuits and debts. If the corporation is sued for negligence or a breach of contract, a judgment would typically be enforced against the company's assets, not your personal ones. This is a significant advantage over operating as a sole proprietor or in a partnership, where you are personally liable for all business debts.

Limits to Liability Protection: Piercing the Corporate Veil

While incorporation offers substantial protection, it's not absolute. A court can "pierce the corporate veil," which means it can disregard the corporate structure and hold the individual director or shareholder personally liable. This is a rare but possible outcome, usually occurring when the corporation is used for fraudulent, illegal, or improper purposes. Situations where a court might look to pierce the corporate veil include:

• Fraud or Improper Purpose: Using the corporation to commit fraud or an illegal act.

• Commingling of Funds: Blurring the lines between personal and business finances by using the corporation's bank account for personal expenses.

• Under-capitalization: Deliberately under-funding the corporation to shield assets from creditors.

• Statutory Liability: Certain statutes, such as the Alberta Prompt Payment and Construction Lien Act and the Income Tax Act, can impose personal liability on directors for breaches of trust / trust funds, even within a corporation.

Importance of Insurance

Even with the liability protection offered by incorporation, having proper insurance is crucial for a contractor in Alberta. Insurance policies, such as Commercial General Liability (CGL) insurance and Professional Liability (E&O) insurance, provide a vital layer of financial protection against claims. Commercial general liability insurance, in particular, is essential for covering legal fees and damages from third-party bodily injury or property damage claims that are common in the contracting industry.

Contracting Out of Incorporation's Personal Liability Protections

Although, the law creates legal separation between the corporation and the contractor, most major parties contracting with the contractor (i.e., banks, equipment lessors, supply companies, the contracting party) will seek to protect their interests by requiring a contractual exception to this protection. This is most often seen when these parties (creditors) require personal guarantee or personal indemnification from the contractor to secure a loan, equipment lease, supply or a major contract [more on personal guarantees].

As such, when you're looking to take on work as an independent contractor that requires you to incorporate and operate through a corporation, you would be well served by seeking the professional services of an experienced corporate lawyer. For incorporation and other relevant legal service for independent contractors in Alberta, contact our law firm  at 403-400-4092 or via email at Chris@NeufeldLegal.com to schedule a confidential initial consultation.

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