Is your manufacturing business creditor-proof?

Creditor-proofing is a good practice that protects your assets in during litigation.

Creditor-proofing is a legal strategy that protects your assets from creditors and litigants.

It involves numerous legal and financial strategies designed to make it difficult for creditors and claimants to seize and sell your assets to recover their debts and claims.

A well-executed creditor-proofing plan is an effective way to avoid and settle litigation claims. If there are no assets to go after, then the claimant is less likely to proceed with litigation. Litigants are hesitant to pursue a claim if the defendant does not have assets available to satisfy a successful claim.

Why Creditor-Proofing?

Unfortunately, the more successful you become, the greater the risk you have of getting sued. Our society is litigious and is becoming increasingly so. As a result, you should always ask yourself if you are doing everything you can to protect your wealth, assets, and business.

Although no single creditor-proofing plan is completely guaranteed, some strategies exist that can better protect your assets. Your strategy depends on your level of wealth, acceptable loss, and acceptable risk. Some of the more common strategies include:

• Incorporate your business. This limits your liability and that of any shareholders. However, this protection is not absolute, and certain circumstances exist in which the shareholders, directors, and even employees can be held personally liable for third-party claims.
• Place funds in a retirement structure. A Registered Retirement Savings Plan (RRSP), Registered Retirement Income Fund (RRIF), and Retirement Compensation Arrangement (RCA) all offer some protection. However, these products are not completely foolproof and should be discussed with your financial advisor.
• Set up a trust in Canada. This can be an effective way to protect assets from creditors. A trust is a legal arrangement in which a trustee holds property for the benefit of a beneficiary. If the trust is structured properly, assets held in the trust can be protected from the creditors of the beneficiary.
• Purchase insurance. Insurance is a simple and effective way to protect assets from creditors. For example, life insurance policies and insurance products that have an investment component can provide a level of protection from creditors.
• Use the Personal Property Security Act (PPSA) [Ontario only]. The PPSA allows for the creation and enforcement of security interests in personal property. Utilizing the PPSA to secure intercompany and shareholder loans is an effective creditor-proofing strategy.
• Set up an offshore structure. This usually involves creating a limited liability company or an offshore trust in a creditor-proof, friendly jurisdiction. Using an offshore strategy typically makes it more difficult for litigants and creditors to access defendants’ assets and requires plaintiffs to pursue their claims in a foreign jurisdiction that has specific laws in place that help protect assets. For example, to be successful, a creditor challenging a Nevis asset protection trust must prove not only that the settlement or disposition was made with the principal intent to defraud the creditor, but also that at the time it took place, it rendered the person advancing the funds insolvent or without property. The plaintiff has the burden of proving its case by satisfying the higher beyond a reasonable doubt standard.

Potential Pitfalls

While creditor-proofing can be an effective way of protecting assets from creditors and litigants, several potential pitfalls must be considered. These include:

1. Fraudulent Transactions.

One of the biggest pitfalls is setting up what is deemed to be a sham or fraudulent transaction. Federal and provincial laws prohibit fraudulent conveyances, and the courts can deem certain types of transactions to be fraudulent if they are made with the intent to defeat, delay, or hinder creditors.

It should be noted that a claimant that was not even a creditor at the time that a transaction took place may be able to attack a past fraudulent transfer. The Ontario Court of Appeal in the recent case of the Ontario Securities Commission v. Camerlengo Holdings Inc. et. al. (2023 ONCA 93) ruled that a transaction can be overturned if at the time of the transaction the transferring party thought that there would be a risk of future creditor claims and the transfer was made with the intention of defeating such creditor claims.

2. Badges of Fraud

The Ontario Court of Appeal in the Camerlengo Holdings Inc. case referenced badges of fraud associated with a conveyance that could help a court determine whether a transaction was to be considered fraudulent.

Timing, paying reasonable consideration for a conveyance, ensuring that there is a proper business purpose relating to a transaction, as well as several other factors must be considered when structuring the creditor-proofing plan.

A proper plan that avoids or minimizes the badges of fraud is required to reduce the chance of a court deeming a creditor-proofing transaction to be fraudulent.

3. Tax Implications

Creditor-proofing strategies can have significant tax implications. For example, setting up an offshore structure can result in layers of complexity to your tax reporting and tax planning structures.

4. Cost

Creditor-proofing strategies can be expensive to implement and maintain. Setting up a plan normally involves obtaining professional legal and tax advice. Creditor-proofing is a complex process that requires careful planning and execution. While there are several common strategies that can be used to protect assets from creditors, it is important to consider the potential pitfalls and to seek professional advice before implementing any creditor-proofing strategy.

Mark Borkowski is president of Mercantile Mergers & Acquisitions Corp., www.mercantilemergersacquisitions.com and Hogarth Clauzel is a senior counsel and consultant at H. Clauzel Corporate & Commercial Law Practice, www.clauzelco.com.