This post, the first of a series on directors’ duties, highlights six key concepts with which directors of Canadian business corporations should be familiar:
- Duty to manage;
- Fiduciary duty;
- Duty of care;
- Business judgment;
- Conflict of interest; and
Having established this foundation, we will look in future posts at some specific issues that concern Canadian directors.
1. Duty to Manage
The duty to manage is stated as follows in the Canada Business Corporations Act (CBCA):
Subject to any unanimous shareholder agreement, the directors shall manage, or supervise the management of, the business and affairs of a corporation.
As this suggests, the managerial responsibilities of a board of directors are both direct and indirect. Boards will typically delegate the day-to-day management of the business to professional managers, led by the corporate officers. They will then perform a supervisory or oversight role with respect to these decisions, in addition to being directly responsible for the company’s compliance with corporate statutes and other legal obligations and setting the overall direction of the corporation (e.g. with respect to corporate finance activity or potential combinations or divestitures).
The CBCA prohibits the delegation of a number of functions, including the following:
- Submission of questions to shareholder votes;
- Authorization of an issuance of securities;
- Declaration of dividends;
- Approval of financial statements, management proxy circulars, take-over bid circulars and financial statements; and
- Adoption, amendment or repeal of corporate by-laws.
As the CBCA “duty to manage” provision reproduced above indicates, the shareholders may, through a unanimous shareholder agreement (USA), remove any or all of the board’s powers, but only to the extent that those who assume those powers also assume all of the duties and liabilities that would otherwise have belonged to the board.
Management of the corporation requires regular attendance at board meetings. Under the CBCA, absent directors are deemed to have consented to any action taken or resolution passed at the meeting, although there is a mechanism for registering a dissent ex post facto. One possible consequence of a failure by a board or its members to engage actively with the issues facing the company may be the potential loss of the protection that the “business judgment rule” normally affords the board (see the discussion below)
2. Fiduciary Duty
As the directors exercise the managerial responsibilities just described, and even outside of their activity as a board, they must observe a fiduciary duty (or duty of loyalty) to the corporation.
What does a fiduciary duty entail? Simply put, it is a duty to safeguard and pursue the interests of another person as though you were that person, setting aside your personal interests while doing so. In the case of a corporate director, the “person” to whom the duty is owed is the corporation. As stated in Section 122(1) of the CBCA:
Every director and officer of a corporation in exercising their powers and discharging their duties shall act honestly and in good faith with a view to the best interests of the corporation.
It is important to emphasize once again that the fiduciary duty is owed to the corporation as such, rather than to shareholders, creditors, employees or other stakeholders or constituencies of the corporation, or to any one of them. The “best interests of the corporation” will often depend on context. However, at a minimum, it may be said that the directors’ fiduciary duty requires that directors ensure that the corporation meets its statutory obligations. Moreover, the Supreme Court of Canada has stated that the “best interests” of the corporation are “not confined to short-term profit or share value” but look instead to longer term interests (assuming that the corporation is an “ongoing concern”). This duty also means that, notwithstanding that a director may be appointed by a particular shareholder, his or her duty is owed more broadly to the corporation and not to that particular shareholder.
But what about the shareholders and other stakeholders? While their interests will often be congruent with the interests of the corporation, to the extent that they are not, the board’s duty is to pursue the best interests of the corporation. Having said that, the Supreme Court of Canada has nevertheless held that, in determining the nature of the best interests of the corporation, the directors may be obliged to consider the interests of shareholders, bondholders, employees and other stakeholder groups. Whether, and to what extent, such consideration should extend beyond making note of the concerns of those groups is not entirely clear, but it does underscore the advantage of ensuring a robust discussion of issues by the board and the importance of appropriate record-keeping with respect to such discussions.
In addition to the high-level guidance referred to above, Canadian courts have provided some specifics about the nature of the duty. In particular, the Supreme Court of Canada noted in Peoples Department Stores v. Wisethat the statutory fiduciary duty under the CBCA (and similar provincial statutes) requires that directors:
- Act honestly and in good faith vis-à-vis the corporation;
- Respect the trust and confidence that have been reposed in them to manage the assets of the corporation in pursuit of the realization of the objects of the corporation;
- Avoid conflicts of interest with the corporation;
- Not abuse their position for personal benefit;
- Maintain the confidentiality of information they acquire by virtue of their position; and
- Serve the corporation selflessly, honestly and loyally.
Avoiding conflicts of interest and refraining from using one’s position for personal gain are discussed below in the specific contexts of contracts between the corporation and its directors (or entities in which directors hold an interest) and the “corporate opportunities” doctrine.
3. Duty of Care
In Canadian law, the duty of care is distinct from the fiduciary duty, as opposed to the U.S. where, under the corporate law of Delaware and other jurisdictions, the duty of care is considered to be part of the fiduciary duty. However, except in situations governed by Quebec’s Civil Code, the duty of care is not an independent foundation for legal actions. Rather, as stated by the Supreme Court of Canada, the duty is relevant to the assessment of the “standard of behaviour that should reasonably be expected” of a director and is therefore most likely to come into play where a board (or individual director) is sued in tort (e.g. with respect to alleged negligence) or under the oppression remedy.
According to the CBCA, the duty of care requires a director to “exercise the care, diligence and skill that a reasonably prudent individual would exercise in comparable circumstances.” While the “reasonably prudent individual” is an objective standard, the court will take into account the context of the situation to determine whether the standard has been met in particular circumstances.
In determining whether a director has met the standard expected of him or her, the focus will generally be on whether he or she has turned his or her attention to the matter in question and considered it with a degree of competence that is consistent with what a reasonably prudent person would exhibit in comparable circumstances. The competence expected of a particular director may also vary based upon the professional experience of that director. The duty of care requires that directors’ decisions must be made on an informed and reasoned basis. Unlike the fiduciary duty, the duty of care under the CBCA may be owed to shareholders, creditors and other stakeholder groups (which explains its applicability in tort and oppression actions, in which plaintiffs would typically be members of such groups).
Directors should take active steps to inform themselves about all material information and review such information with care. They should document their decision-making process to be able to demonstrate that they exercised care, diligence and skill in reaching their decisions.
4. Business Judgment
In considering whether directors have complied with their duty of care, the courts may afford them the benefit of the “business judgment rule”. This basically means that the court will often decide to defer to business decisions provided that they fall within a range of reasonable alternatives. In practice, the availability of the business judgment rule is often a function of the process followed by the board in reaching its decision, rather than of an analysis of the merits of the board’s decision. Canadian courts recognize that a situation may look very different, before the fact, in a boardroom than it will, after the fact, in a courtroom. They also generally acknowledge that a judge is unlikely to have as keen a sense of what makes business sense for a company as its own board of directors is likely to have – at least when it is demonstrably acting honestly, diligently and with a view to the corporation’s best interests.
While appealing to the business judgment rule will not always save a board from liability for breach of the duty of care (even when it has acted in good faith), it remains the case that Canadian courts tend to be reluctant to second-guess a board’s honest and informed business decisions. To maximize the degree of protection afforded by the business judgment rule, directors should try to ensure not only that they are well-informed but that, if necessary, they can prove that they were well-informed. To ensure that a decision is “informed”, expert advisors should be consulted where appropriate. Note, however, that it can be important to be able to show that the board did not accept the credentials or advice of any such expert uncritically. Decisions should therefore be documented appropriately, making it clear that they were the result of deliberation by the board (taking into account such expert advice as may have been received and considering it in light of the board’s understanding of the best interests of the corporation).
5. Conflict of Interest
Directors can face a number of conflict of interest issues, particularly in light of their fiduciary duty. Two of the more common situations in which conflicts can arise are contracts between the company and the director and the “appropriation” of corporate opportunities. The first of these arises when the director himself or herself (or an entity related to him or her or for which he or she is employed or is a director) wants to enter into a contractual relationship with the company. The second arises when the director, in his or her own right, wishes to take up an opportunity that has been presented to the corporation.
Contracts and transactions between a director and the corporation are regulated by Section 120 of the CBCA. According to that section, a director must disclose in a prescribed manner the nature and extent of any interest in a material contract or transaction to which he or she is a party (or has a material interest in a party). An interested director may not vote on any resolution relating to such arrangements unless it is a contract (i) relating primarily to his or her remuneration, (ii) for indemnity or insurance under the CBCA or (iii) with an affiliate.
Even after disclosure is made, the transaction must still be approved by non-interested directors and be reasonable and fair to the corporation. There is also a “saving provision”, which provides that a transaction may be approved by special resolution of shareholders retroactively. If these conditions are not satisfied, a court may, on application of the corporation or any shareholder, set aside a contract on any terms it thinks fit (including an accounting of profits or gains).
Directors are also precluded at common law from taking advantage of corporate opportunities. Situations of this type typically arise when, in the course of fulfilling his or her duties, an opportunity for the corporation comes to the attention of a director who is tempted to take that opportunity for himself or herself (or to steer it toward another entity in which he or she has an interest). While each situation must be considered on its own merits, the corporate opportunity doctrine will generally apply even if the fiduciary has resigned his or her position in order to pursue the opportunity and can apply even if the corporation itself has no intention of pursuing the opportunity. Unlike the Delaware General Corporation Law, the CBCA does not expressly permit a corporation to renounce specific classes of corporate opportunities.
The oppression remedy, found in s. 241 of the CBCA, frequently serves as a basis of litigation by dissatisfied corporate stakeholders. One reason for this is that, in keeping with the remedy’s equitable origins, it is highly flexible – not only with respect to the types of remedy that may be ordered but also with the range of persons who may be plaintiffs or defendants to an action. It is not unknown for a director to bring an oppression action, with a relatively common scenario being that of a director who is also a minority shareholder and whose ability to function effectively as a board member has been unfairly compromised by the actions of another shareholder or shareholder group with whom, qua shareholder, he or she is embroiled in a dispute.
The definition of “oppression” is relatively open-ended. According to the CBCA, it includes any act of the corporation or an affiliate, or any exercise of the powers of the directors, that is “oppressive or unfairly prejudicial or that unfairly disregards the interests of any security holder, creditor, director or officer”. One of the key factors in any oppression case is the “reasonable expectation” of the complainant, the breach of which is generally a precondition of an oppression remedy.
While the courts have a great deal of discretion with respect to oppression remedies, it can be said that, as a general rule, an order under the oppression provision of the CBCA is more likely to be made against a director in his or her personal capacity in cases where he or she bears at least some personal responsibility for the oppression, and particularly where he or she has benefitted personally. To take one example, such orders are not uncommon when a director has “virtually total control” of the corporation that committed the act of oppression. While in the past there was some authority that directors could be liable in oppression even where they acted in good faith, the Supreme Court of Canada’s BCE ruling clarified that “wrongful conduct” is in fact a prerequisite of oppression.
In principle, there is no limit to the potential liability of a director (or other defendant) under the oppression remedy. Having said that, it is important to remember that, as an equitable remedy, oppression is intended to be rectificatory rather than punitive. The CBCA also allows oppression remedies to include orders for the replacement of existing directors or addition of new directors and it is also possible for an order preventing the removal of a director to be issued.