DIRECTOR DUTIES AND LIABILITIES (ONTARIO)
To assist you in make an informed decision regarding becoming or continuing as a director, we provide the following outline of the responsibilities and potential liabilities associated with being a director of an Ontario business corporation. In addition, we set out some of the strategies directors may limit their exposure.
Note that our focus in this Update is on private company directors. Additional responsibilities and potential liabilities apply to directors of public companies.
Typically in private, or closely-held companies, the three roles of shareholders, directors and day-to-day officers and managers are all filled by the same people. In our view, corporate governance for these companies refers to how such directors and officers satisfy their corporate responsibilities and limit their potential liabilities to three groups: creditors, investors and employees.
1. GENERAL RESPONSIBILITIES
Subsection 115(1) of the Business Corporations Act (Ontario) (the “Act”) requires that, subject to any unanimous shareholder agreement, the directors of a corporation manage or supervise the management of the business and affairs of the corporation. The term “business” is self-explanatory; the term “affairs” is defined in the Act as meaning the relationships among a corporation, its affiliates (related corporations) and the shareholders, directors and officers of the corporation.
Directors may appoint a managing director or a committee of directors and delegate to that managing director or committee, as applicable, any of the powers of the directors. The managing director must be a resident Canadian or, if a committee of directors is appointed, a majority of the committee members must be resident Canadians. However, this right is constrained by subsection 127(3) of the Act and may be further constrained by the articles and/or by-laws of a corporation. In addition, unless the articles, the by-laws or any unanimous shareholder agreement provide otherwise, the directors may appoint officers and, subject to some exceptions which are set out in subsection 127(3) of the Act, delegate to them power to manage the business and affairs of the corporation.
The following matters, which are set out in subsection 127(3), may not be delegated to a managing director, committee of directors or the officers of the corporation:
(i) the submission to shareholders of any question or matter requiring the approval of the shareholders;
(ii) the filling of a vacancy among the directors or in the office of auditor or the appointment or removal of any chief executive officer, however designated, the chief financial officer, however designated, the chair or the president of the corporation;
(iii) subject to the exception set out in section 184, the issuance of securities except in the manner and on the terms authorized by the directors;
(iv) the declaration of dividends;
(v) the purchase, redemption or other acquisition of shares issued by the corporation;
(vi) the payment of a commission;
(vii) the approval of a management information circular;
(viii) the approval of a take-over bid, directors’ circular or issuer bid circular;
(ix) the approval of any financial statement;
(x) the approval of an amalgamation;
(xi) the adoption, amendment or repeal of by-laws.
Directors as Fiduciaries and Applicable Standard of Care
Subsection 134(1) of the Act requires every director and officer of a corporation in exercising his or her powers and discharging his or her duties to
(i) act honestly and in good faith with a view to the best interests of the corporation; and
(ii) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
The first requirement, to act honestly and in good faith with a view to the best interest of the corporation, represents the statutory recognition that directors and officers are fiduciaries of a corporation. As fiduciaries of the corporation, directors and officers may not permit their personal interests or interests of others to conflict with the responsibilities of their office. Under general legal principles, fiduciaries may not make unauthorized profits, may not delegate their responsibilities, must keep proper accounts and must act honestly, with due diligence and the utmost candour. Some of these principles have been codified and modified by specific sections of the Act.
Example 1: Disclosure of Conflicts. Subsection 132(1) of the Act restricts the right of a director or officer to be a party to a material contract or transaction with the corporation. An example of a situation that may trigger this provision would be a purchase of a service or property by the corporation from a director. If the contract or transaction is material to the corporation the director or officer must disclose the existence of his or her interest in writing to the corporation or request to have such interest entered in the minutes of the directors’ meeting, including the nature and extent of the conflict.
The Act sets out detailed rules specifying when and how such disclosure is to be made and prohibits a conflicted director or officer from voting on any resolution to approve the contract or transaction unless it is an arrangement by way of security for money lent to or obligations undertaken by the director for the benefit of the corporation or an affiliate, relates primarily to his or her remuneration as a director, officer, or employee or agent of the corporation or an affiliate, involves the indemnification of a purchase of insurance for directors or officers by the corporation or is a contract or transaction with an affiliate of the corporation.
The Act also requires that the contract or transaction must also be “reasonable and fair to the corporation at the time it is approved”.
Failure to comply with the disclosure provisions in the Act could render such director or officer accountable to the corporation or its shareholders for any profit or gain realized from the contract or transaction and the contract or transaction void or voidable.
Example 2: Avoid Taking Direction. As fiduciaries of the corporation, directors and officers need not follow the day-to-day advice or wishes of the shareholders or directors, in case of officers, that elected or appointed them. In fact, it is their duty to run the business as they see fit, not as dictated by someone else.
The latter statutory obligation set out in clause 134 (1) (ii), to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances, is typically referred to using the tort law concept of “standard of care”. It includes three elements: skill, care and diligence. The subjective component of this test means that the behaviour that is required of a director or officer will differ as between two persons. Generally, a director or officer need only exhibit such skill as may reasonably be expected from a person of his or her knowledge and expertise. Similarly, a director or officer must exercise care by applying what skills he or she has in activities undertaken by the director or officer. Directors and officers must exercise the diligence of a person who is reasonably prudent. This latter element means that ignorance is generally not a viable defense.
2. SPECIFIC RESPONSIBILITIES
In addition to their general responsibilities, the Act imposes other specific obligations applicable to directors and officers.
(a) Compliance with the Rules and Organizational Documents
Every director and officer is required under subsection 134(2) of the Act to comply with the Act, the regulations, the corporation’s articles and by-laws and any unanimous shareholder agreement in effect.
(b) Safeguarding the Financial Position of the Corporation
The Act requires that directors and officers refrain from taking certain actions which could have an adverse effect on the financial position of the corporation. For example, subsection 38(3) of the Act stipulates that directors may not declare a dividend if there are reasonable grounds for believing that after the payment of the dividend,
(i) the corporation would be unable to pay its liabilities as they become due; or
(ii) the realizable value of the corporation’s assets would be less than the total of its liabilities and its stated capital (money or other consideration paid to the corporation for shares) of all classes.
Under subsection 130(2) of the Act directors who vote for and consent to a resolution authorizing certain corporate actions having an adverse effect on the financial position of the corporation contrary to the Act are jointly and severally liable to restore to the corporation any amounts distributed or paid and not otherwise recovered by the corporation. This means that each consenting director is potentially liable for the full amount. Liability under section 130 is limited to the 2 year period from the date of the resolution authorizing the action complained of.
(c) Insider Liability
Directors and officers must also be aware that they are “insiders” of the corporation and as such are exposed to additional restrictions and potential liability. Under the Act an insider who, in connection with a transaction in a security of the corporation or any of its affiliates, makes use of any specific confidential information for the insider’s own benefit or advantage that, if generally known, might reasonably be expected to affect materially the value of the security,
(a) is liable to compensate any person for direct loss suffered by that person as a result of the transaction, unless the information was known or in the exercise of reasonable diligence should have been known to that person; and
(b) is accountable to the corporation for any direct benefit or advantage received or receivable by the insider as a result of the transaction.
Although the potential for liability under the provision is great, the ambiguity of the various elements required to be proven to establish liability makes it difficult to prove insider trading under the Act. Note that securities laws impose additional constraints on insiders of public companies.
(d) Liability to Employees for Wages
Directors are personally liable to employees in certain circumstances. Under subsection 131 of the Act the directors of a corporation are jointly and severally liable to the employees of the corporation for all debts not exceeding six months’ wages that become payable while they are directors for services performed for the corporation and for the vacation pay accrued while they are directors. However, subsection 131(2) of the Act limits the exposure; a director is only liable if (a) the director is sued while he or she is a director or within 6 months after ceasing to be a director and (b) the action is commenced within 6 months after the debts became payable, and (i) the corporation is also sued but is unable to pay in whole or in part, or (ii) the corporation is bankrupt.
Liability for up to six months unpaid wages is also imposed under the Employment Standards Act, 2000 (Ontario), which has a two year limitation period.
(e) Tax Liability and Other Liabilities
Directors should also be aware that the Income Tax Act (Canada) imposes criminal liability on directors in certain circumstances relating to unpaid taxes. Corporations are required by the Income Tax Act (Canada) to remit source deductions from employees to the Canada Customs and Revenue Agency. Directors may be personally liable for unremitted funds. In addition, directors may be liable for unpaid provincial sales taxes, unpaid Goods and Services Tax and any unpaid Employer Health Tax.
Directors may also be liable for corporate actions under environmental protection and other legislation.
As already mentioned, employees may look to the directors for unpaid wages. In addition, under the Act a “complainant” is able to take certain actions if he or she is of the view that the directors or officers are not discharging their duties.
A “complainant” is defined in section 245 as
a registered holder or beneficial owner, and a former registered holder or beneficial owner, of a security of a corporation or any of its affiliates,
a director or an officer or a former director or officer of a corporation or any of its affiliates, and
any other person who, in the discretion of the court, is a proper person to make an application.
It is worth noting that bond holders likely have standing under clause 245(a) of this provision, but ordinary trade creditors holding unsecured debt obligations generally do not. However, trade creditors may qualify under clause (c) of the section 245 definition.
Derivative Action. Section 246 enables a complainant to commence an action on behalf of the corporation, subject to certain conditions which are set out in subsections 246(1) and (2).
Oppression Remedy. Subsection 248(1) of the Act authorizes a complainant to apply to the court if the interest of any security holder, creditor, director or officer of the corporation is being subjected to oppressive or unfairly prejudicial activity or activity that unfairly disregard the interests of any security holder, creditor or officer of the corporation.
4. SUMMARY – SOME PRACTICAL ADVICE
(a) Know and Comply with the Rules and the Corporation’s Organizational Document
Directors and officers should familiarize themselves with the Act, the regulations and, particularly, the articles, by-laws and any unanimous shareholders agreement in effect. Failure to do so could result in liability under subsection 134(2) and other provisions of the Act.
(b) Appoint Effective Committees and Officers
Subject to some exceptions, the Act authorizes directors to appoint committees and officers and delegate to them certain powers. Ensure that any such appointments are made with a view to the best interests of the corporation.
(c) Use Experts
The Act provides a defense to sections 130 (financial responsibilities) and 134 (fiduciary duties) for directors who rely in good faith upon financial statements prepared by an officer or auditor of the corporation or, generally, upon a report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by any such person.
Select knowledgeable, competent officers and consultants you trust and document their advice and your reliance upon same.
(d) Get Indemnified and Insured
Indemnification.Subsection 136 (1) of the Act authorizes a corporation to indemnify a director or officer, a former director or officer of the corporation or a person who acts or acted at the corporation’s request as a director or officer of a subsidiary, and his or her heirs and legal representatives. Such an indemnity may relate to all costs, charges and expenses, including an amount paid to settle an action or satisfy a judgment, reasonable incurred by such indemnified person in respect of any civil, criminal or administrative action or proceeding to which he or she is made a party by reason of being or having been a director or officer. However, the indemnification must be conditional upon:
(a) the person having acted honestly and in good faith with a view to the best interests of the corporation; and
(b) in the case of criminal or administrative action or proceeding that is enforced by a monetary penalty, the person must have had reasonable grounds for believing that their conduct was lawful.
Insurance.Subsection 136(4) of the Act also authorizes a corporation to purchase and maintain insurance for the benefit of any director or officer, former director or officer of the corporation or a director or officer of a subsidiary of the corporation who acted as such at the request of the corporation, and such person’s heirs and legal representative. The person may be insured against any liability incurred by the person in his official capacity and provided such person has acted honestly and in good faith with a view to the best interests of the corporation.
(e) Install a Unanimous Shareholder Agreement
The Act empowers shareholders to usurp the directors’ powers in any situation through the use of a unanimous shareholder agreement. Such an agreement can limit the directors’ right to manage, to the extent stipulated in the agreement. However, a unanimous shareholder agreement not only transfers power to the shareholders but also the legal and equitable obligations to the corporation as were formerly owed, collectively and individually, by the board of directors. Such is the effect of subsection 108(5) of the Act. Shareholders thereby acquire, and the directors are relieved of, all the rights, powers, duties and liabilities (including liabilities for unpaid employee wages) of a director, to the extent such agreement restricts the discretion or powers of the directors.
Obviously the installation of a unanimous shareholder’s agreement would only protect non-shareholder directors and only to the extent of the agreement.
Resigning as a director of the corporation is an effective means of limiting liability. However, resigning will generally not protect a director from liabilities incurred while he or she was a director. In addition, note that subsection 115(4) of the Act provides that, subject to a few limited exceptions which are set out in subsection 115(5), where all of the directors have resigned or have been removed by the shareholders without replacement, any person who manages or supervises the management of the business and affairs of the corporation is deemed to be a director for the purposes of the Act.