Individuals who serve as directors or offices of public companies in Canada face an increasing amount of shareholder litigation and a complex web of legal and regulatory provisions that must be  managed, navigated and adhered to.  The challenge to directors only increases when the company is insolvent, on the eve of insolvency or otherwise in some form of financial distress.  If the insolvency is driven by a liquidity crisis the company may be hard-pressed to maintain day-to-day operations and preserve going concern value for stakeholder groups.  Alternatively, if the problem is caused by a heavily leveraged balance sheet the company is at risk of breaching debt covenants, facing resulting creditor enforcement activity and the potential loss of control of the company’s assets.  In either instance it is particularly important for directors to operate with a heightened awareness of their fiduciary and other duties and knowledge that personal exposure may result from ill-informed decisions that harm the interests of third-parties.

In most common law jurisdictions including British Columbia, Alberta and Ontario directors have a statutory duty to act honestly and in good faith and to exercise their duties with a reasonable degree of care, diligence and skill.  Leading Canadian decisions on director and officer duties, including decisions from the Supreme Court of Canada in Peoples Department Stores Inc. (Trustee of) v. Wise, 2004 SCC 68 and BCE Inc. v. 1976 Debentureholders, 2008 SCC 69, generally establish that an honest and good faith but albeit unsuccessful attempt to address a corporation’s financial problems does not constitute a breach of these duties.  Protection is offered to those who make prudent, reasonable decisions on an informed basis in light of all relevant circumstances and on an objective standard.  Courts in Canada accept the rationale of the “business judgment rule” and recognize they should be reluctant to second-guess the business considerations that are often involved in corporate decision-making.

The duty of a director is one that is continuously owed is to the corporation (as opposed to shareholders or creditors).  The interests of shareholders and creditors are generally aligned when a corporation is solvent and operating as a going-concern entity. If the  corporation approaches the “vicinity of insolvency” or becomes insolvent the duty remains to the corporation but the desires of creditors and shareholders will reach a point of divergence, with the former desiring actions that allow repayment of their debts and the latter likely focused on pursuing economic upside irrespective of risk.  In such circumstances the obligation to act in the best interests of the corporation will require an assessment of the impact that a particular action or decision will have on a corporation’s creditors, including whether it could reasonably be expected to enhance or jeopardize the ability of the corporation to satisfy its obligations.  Such considerations are important in Canada because directors face “…the broadest, most comprehensive and most open-ended shareholder remedy in the common law world”, namely the oppression remedy.  The remedy is not limited to claims by shareholders and creditors may seek relief either directly or through the Court exercising its discretion to grant them standing as an affected party under the relevant legislation.  This provides a nearly unlimited opportunity for disaffected stakeholders, regardless of whether they are holders of debt or equity interests, to review and challenge the decisions of directors in respect of real or perceived prejudicial, unfair and oppressive conduct.

The risk of personal liability to directors in instances where the corporation is either insolvent or in financial distress can be mitigated in several ways, most notably by the implementation of and adherence to appropriate corporate governance policies and procedures before fiscal issues present themselves.  When issues of insolvency arise best practices generally include the following:

  • Ensuring that critical decisions are made by disinterested directors and that conflicts of interest are identified, documented and properly managed. Depending on the particular circumstances this may involve the formation of an independent committee of directors to pursue strategic alternatives or make recommendations on particular issues to the board as a whole.
  • Retaining financial, legal and other professional advisors to provide informed advice on relevant issues. This not only assists with corporate decision making also serves as evidence of an intention to by the board to make informed choices which, for the reasons previously discussed, is fundamentally important in defending potential litigation regarding an alleged failure to discharge fiduciary duties.
  • Obtaining and/or reviewing director and officer insurance liability policies to ensure a broad scope of coverage and policy limits that are appropriate in light of the size of the company and the anticipated liabilities that might arise against directors.
  • Planning for contingencies, including the potential need to obtain protection from creditors under either the Companies’ Creditors Arrangement Act (Canada) or theBankruptcy and Insolvency Act (Canada) if developments warrant.