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Director and parent company liability

Liability

Under what circumstances can a director or parent company be held liable for a company’s insolvency?

Directors of a solvent corporation generally owe two duties to the corporation and its shareholders: 

  • duty of care; and
  • duty of loyalty. 

Duty of care requires acting in the best interests of the corporation, generally by making decisions on an informed and rational basis. Duty of loyalty requires that a director perform his or her function without conflict between his or her fiduciary duties and self-interest, by refraining from engaging in activities that permit the receipt of an improper personal benefit from his or her relationship to the corporation. 

The potential for insolvency heightens the scrutiny of all parties in the directors’ decision-making process. Directors of a solvent corporation generally owe fiduciary duties exclusively to the corporation’s shareholders. However, when a corporation is insolvent the board’s fiduciary duties may extend to the corporation’s creditors, and the general duties owed by directors expand to include an obligation to maximise the value of the enterprise for the entire community of interests. Courts generally require that directors and officers of an insolvent corporation exercise the care and skill that a person of ordinary prudence would exercise in dealing with his or her own property.

Defences

What defences are available to a liable director or parent company?

The business judgement rule protects directors by granting judicial deference to their business decisions. There is a rebuttable presumption that directors of a corporation have acted on an informed basis, without self interest, in good faith and in the honest belief that the actions taken were in the best interests of the company. This presumption imposes a significant burden on a plaintiff to show that a company’s board of directors has acted in a manner inconsistent with their fiduciary duties or that their actions were irrational. The presumption can be overcome by demonstrating that there has been a breach of fiduciary duties, or in cases of fraud, bad faith, gross negligence or self-dealing. If the protection of the business judgement rule is lost, the burden shifts to the director to demonstrate the fairness of the challenged transaction.

Due diligence

What due diligence should be conducted to limit liability?

Practically speaking, a director should be well informed about the corporation’s business direction, financial condition and plans for growth. A director also should attend board meetings regularly, attentively review written materials prepared for the meetings and analyse management assumptions and strategic initiatives. Board deliberations should consider the possible effect of alternative options on stockholders and creditors. Directors may rely in good faith on management and expert advice of outside advisers, including counsel, that are reasonably believed to be qualified to provide the advice that they are giving. However, directors possessing a particular area of expertise may not rely blindly on an opinion of an expert and should challenge that opinion to the extent that their expertise dictates.

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