Photo of Joe BrennanBy Joe BrennanDecember 06 2016
Business Law

“Primer” on Directors’ Responsibilities – and Potential Liabilities – in Canada

A friend was recently invited to join the board of directors of a private Canadian company. Before deciding on whether to accept that invitation, he prudently asked for a summary of the responsibilities, and potential liabilities, that stem from being a director.  While no summary can adequately address the myriad of responsibilities, fact patterns and potential liabilities that a director may face, below is my best effort at a “primer” on some of the more prominent responsibilities and potential liabilities that a director of a corporation in Canada may face.  I hope you find it helpful. 

ROLE OF THE BOARD OF DIRECTORS

·         Directors are ultimately responsible for managing, or supervising the management of, the corporation.

·         Notwithstanding the delegation of day-to-day management of the corporation to executive officers, the directors must retain ultimate control over the corporation. 

A.         Supervise, Direct and Oversee Management

·         The board supervises, directs or oversees the business and affairs of a corporation. 

·         It appoints executive officers who are delegated responsibility for the day-to-day management of the corporation’s affairs (i.e. the CEO, President, CFO, and other senior executives). 

·         It sets a strategic direction for management to follow and sets limits on management’s ability to act without first seeking board approval.

·         And it exercises proper oversight to ensure that management is following that strategic direction and staying within those limits. 

B.         Responsibility for Strategic Planning and Risk Identification

·         The board is responsible for the corporation’s strategic direction.

·         Management may prepare, but the board must ultimately approve, the corporation’s strategic plan that identifies business opportunities, business risks and the corporation’s approach to those business opportunities and risks (i.e. review and approve strategic plans, operating plans and budgets).

·         The board must take steps to be satisfied that the strategic plans that it has approved are being effectively implemented.

·         And the board should ensure that appropriate internal and external monitoring and audit systems are in place to ensure that the corporation’s affairs are being run responsibly.

FIDUCIARY DUTY AND DUTY OF CARE

·         Corporate statutes impose two principal duties on directors:

  • Each director must act honestly and in good faith with a view to the best interests of the corporation (referred to as a “fiduciary duty”).
  • Each director must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances (referred to as a “duty of care”).

·         Directors cannot contract out of these responsibilities.

·         Directors may be personally liable for any breach of these duties.

·         To protect themselves, directors need to be concerned with the process as much as the result.  In the Peoples Department Stores case, the Supreme Court of Canada stated:

  • “Directors and officers will not be held to be in breach of the duty of care … if they act prudently and on a reasonably informed basis. The decisions they make must be reasonable business decisions in light of all the circumstances about which the directors or officers knew or ought to have known. In determining whether directors have acted in a manner that breached the duty of care, it is worth repeating that perfection is not demanded. Courts are ill-suited and should be reluctant to second-guess the application of business expertise to the considerations that are involved in corporate decision making, but they are capable, on the facts of any case, of determining whether an appropriate degree of prudence and diligence was brought to bear in reaching what is claimed to be a reasonable business decision at the time it was made.”

·         Where reasonable to do so, and subject to appropriate scrutiny, the board is entitled to rely on:

  • Information prepared by management, including the financial statements; and
  • Reports of experts, such as lawyers, accountants and appraisers.

·         Suggestions:

  • Be engaged; ask questions.
  • Devote adequate time to consideration of matters.
  • Avoid conflicts of interest; when conflicts do arise, appoint special committees.
  • When necessary, retain experts to advise the board.
  • Document the process followed.

OTHER STATUTORY RESPONSIBILITIES AND LIABILITIES

·         There are numerous statutes that add additional responsibilities and potential liabilities to directors.  Some of these are set out below.

A.         Conflicts of Interest

·         Where a director, or any entity that the director is affiliated with, has an interest in any material contract with the corporation, Canadian corporate statutes typically require the director to:

  • Disclose in writing to the corporation the director’s interest in the material contract (or request that the interest be entered in the minutes of a meeting of the board); and
  • Abstain from voting on the material contract (unless the contract involves the director’s remuneration or an indemnity or insurance in which the director has an interest).

·         Some statutes even require the director to refrain from attending the part of the board meeting where the material contact is discussed.

·         If the director fails to provide the required disclosure or, where required, abstain from voting:

  • The director may be required to account to the corporation or its shareholders for any gain or profit realized from the contract; and
  • The corporation or its shareholders may apply to the court to have the contract set aside.

·         These provisions apply only to contracts that are material either to the corporation or the director, not to contracts that do not meet this threshold.

B.         Corporate Statutes - Solvency Tests

·         The “solvency tests” under most Canadian corporate statutes provide that a corporation is prohibited from completing certain identified transactions if:

  • There are reasonable grounds for believing the corporation is, or would be after the transaction, unable to pay its liabilities as they become due; or
  • The realizable value of the corporation’s assets would, as a result of the dividend, be less than the aggregate of its liabilities and the stated capital of all classes of shares.

·         These transactions include:

  • Purchasing, redeeming, retracting or otherwise acquiring its own shares;
  • Paying a dividend;
  • Providing loans, guarantees or other financial assistance to certain related parties; and
  • Making payments to a shareholder who has exercised statutory dissent rights.

·         Directors could incur personal liability if they vote for or consent to such transactions when the corporation does not satisfy the insolvency tests.

·         Directors will be deemed to have consented to a resolution unless they register their dissent at the time the resolution is approved or as soon as they otherwise become aware of it.

·         In determining whether the corporation passes the solvency tests, the directors are entitled to rely on the corporation’s financial statements or on the advice of outside advisors provided such reliance is made in good faith and is reasonable in the circumstances.

·         In addition, directors could personal liability if they vote for or consent to issue shares for property or past services which have a fair market value less than the money the corporation would have received if it had issued the shares for money.

C.         Environmental Legislation

·         Any person, whether it be a corporation or an individual, that causes or permits damage to the environment may be subject to liability under environmental legislation.

·         Any person that owns, leases, or is otherwise in management or control of a property that has been subjected to environmental damage may be subject to liability under environmental legislation.

·         Directors may be required to pay for rectification of environmental damage.

·         Further, directors may be personally liable for some of the environmental offences committed by the corporation. 

D.         Wages, Vacation Pay and Termination Pay

·         Under most corporate and employment standards statutes, directors are jointly and severally liable for all debts, not exceeding six months’ wages, payable to each employee for services performed for the corporation while they were directors.

·         This typically includes unpaid employee wages, including accrued vacation pay, and may include contributions to benefit or pension plans.

·         However, it does not typically include termination pay or pay in lieu of notice under corporate statutes.

E.         Source Deductions

·         A corporation is required to deduct certain amounts from its employees’ wages or salaries and to remit those amounts to various levels of government:

  • Income taxes
  • Employees’ premiums for employment insurance
  • Contributions to the Canada Pension Plan

·         If the corporation fails to deduct and remit these amounts, those individuals who were directors at the time the amount should have been remitted may be jointly and severally liable for these amounts as well as for interest and penalties.

·         A due diligence defence may be available to directors who have taken the steps necessary to ensure that source deductions are being made and remitted. 

F.         Occupational Health and Safety Matters

·         Directors must take all reasonable care to ensure that the corporation complies with the provincial health and safety legislation and any applicable orders and requirements from the governmental authorities including obtaining comfort that:

  • Management has identified all areas of operation in which precautions should be taken.
  • The corporation has provided proper training and supervision to employees.

·         Failure to do so may result in director liability.  In Alberta, directors who fail to comply with their obligations under the Occupational Health and Safety Act may be subject to fines of up to $1,000,000 and prison terms of up to one year.

·         Directors can also face possible criminal charges for health and safety violations under the Criminal Code (i.e. anyone who has authority to direct how another person works is under a legal duty to take reasonable steps to prevent bodily harm to that person). If convicted, a director could face a fine and imprisonment. 

G.         Tax Liabilities

(a)        Source Deductions and Other Remittances

·         As stated above, a corporation is required to deduct certain amounts from its employees’ wages or salaries and to remit those amounts to various levels of government:

  • Income taxes
  • Employees’ premiums for employment insurance
  • Contributions to the Canada Pension Plan

·         If the corporation fails to deduct and remit these amounts, those individuals who were directors at the time the amount should have been remitted may be jointly and severally liable for these amounts as well as for interest and penalties.

·         A due diligence defence may be available to directors who have taken the steps necessary to ensure that source deductions are being made and remitted.

·         The same applies to amounts paid or credited to non-residents of Canada that are subject to Canadian withholding tax. 

(b)        Offences of the Corporation

·         Under the Income Tax Act, a director may be liable for any offence if that director “directed, authorized, assented to, acquiesced in or participated in” the commission of the offence.

(c)        GST/HST

·         A director may be held liable for any GST or HST required to be remitted by the corporation under the Excise Tax Act.

·         A director may avoid liability by establishing a “due diligence defense.”

STEPS TO REDUCE THE RISK ASSOCIATED WITH BEING A DIRECTOR

A.         Fulfill Fiduciary Duty and Duty of Care

·         Act honestly and in good faith with a view to the best interests of the corporation.

·         Exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

B.         Obtain Indemnity Agreement

·         A corporation is permitted to indemnify a director for negligent acts provided the director acted in good faith with a view to the best interests of the corporation.

·         A corporation is also permitted to indemnify the director for fines in criminal or administrative proceedings provided that the director had reasonable grounds for believing that the director’s conduct was lawful.

·         But the indemnification in the statutes is permissive rather than mandatory and therefore it is prudent to obtain and an indemnification agreement that contractually obligates the corporation to indemnify the director or officer to the fullest extent permitted by law.  

·         The indemnification agreement should further specify the procedural rights and responsibilities of each of the corporation and the affected director or officer.  For example, an indemnification agreement will typically obligate the corporation to pay, in advance, defense costs as such expenses are incurred so that the director or officer is never out of pocket for such expenses.  

·         Having an indemnification agreement in place that sets out these rights and responsibilities will be make it easier for the affected director or officer to enforce the indemnification obligation against the corporation in a court of law, if necessary. 

C.         Obtain D&O Insurance

·         Notwithstanding the foregoing, there are many circumstances where the corporation’s indemnification obligations under corporate law or under an indemnification agreement are inadequate, difficult to access or unavailable.  For example:

  • The corporation may become insolvent and unable to honour its indemnification obligations.
  • The corporation may have a board that is hostile to the indemnified party and therefore refuses to honour its indemnification obligations.
  • Indemnification may simply be unavailable if a court finds that the indemnified party’s conduct was not in the best interests of the corporation or that the indemnified party had no reasonable grounds for believing his or her conduct was lawful.

·         As such, it is prudent to ensure that the corporation also has in place adequate D&O insurance coverage.

D.         Resign

·         Unfortunately, there may be circumstances where the only means to avoid further potential personal liability is to resign.

·         However, this will only protect the director from exposure to any liability for events after the effective date of the resignation.

Invitation for Discussion:

If you would like to discuss this blog in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Shea Nerland LLP.

Disclaimer: 

Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.

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