The current state of capital markets combined with deteriorating financial conditions generally have caused directors to anticipate challenging times ahead for their enterprises. In addition to examining assumptions inherent in existing business plans and spending priorities, directors are examining liquidity and solvency issues more closely as part of enterprise risk management programs. Against this backdrop, directors are seeking confirmation that their decisions are being made in compliance with statutory and common law duties and that appropriate steps are being taken to shield directors from potential personal liabilities to the extent possible.

Shifting Stakeholders

Participants in existing capital structures are shifting dramatically and secondary market participants often have differing objectives and expectations for their investments. This fundamental shift is resulting in a more robust involvement and activist behaviour on the part of varied interests – interests which are looking to compel actions on the part of corporate boards.

Existing Duties - Unchanged in Times of Financial Turmoil

Most Canadian corporate statutes require directors and officers to act honestly and in good faith with a view to the best interests of the corporation, and to exercise the care, diligence and skill that a reasonably prudent person would in comparable circumstances. Corporate directors must adhere to these duties while not unfairly disregarding, prejudicing or oppressing the interests of the corporation's stakeholders.

The Supreme Court of Canada has confirmed that even in times of financial distress, fiduciary duties and duties of care remain owing to the corporation; they do not shift to the corporation's creditors. However, in determining what is best for the corporation, directors must take into account and balance the interests of various stakeholders, including creditors.

Compliance with Duties

To demonstrate that the appropriate level of fidelity and the requisite degree of diligence and skill have been applied in reaching a reasonable business judgment, directors must act selflessly and in the best interests of the corporation. They must also act on an informed basis and should adhere to a decision-making process that is both well documented and transparent. This can extend to actively managing the actions and decision making processes of others within the corporation, and establishing policies and procedures that minimize the prospect of others making misrepresentations about the state of the corporation's affairs.

Oppression Remedy

Directors will open themselves up to potential oppression remedy claims in the absence of a credible commercial explanation as to why pursuing a particular course was in the best interests of the corporation and did not unfairly disregard, unfairly prejudice, or oppress the interests of potential complainants. This explanation will be viewed in hindsight based on the evidence available. Generally speaking, any decision taken should be seen objectively as having a reasonable basis for maintaining or increasing the overall enterprise value of the corporation, preserving the realizable value of its assets and fulfilling the reasonable expectations of the potential claimants (where possible).

Process Protections

Greater reliance on process and documentation for decision making will be required to ensure compliance with statutory and common law duties and to minimize liabilities to third party stakeholders. Directors can derive significant protection by obtaining (and relying on) appropriate expert advice. For example, under most corporate statutes, directors are not liable for breaches of fiduciary duties or duties of care if they relied in good faith on:

(a) financial statements of the corporation represented to the directors by an officer of the corporation or in a written report of the auditor of the corporation as fairly depicting the financial condition of the corporation;

(b) an interim or other financial report of the corporation represented to the directors by an officer of the corporation as fairly depicting the financial position of the corporation;

(c) a report or advice of an officer or employee of the corporation, where it is reasonable in the circumstances to rely on the report or advice; or

(d) a report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by any such person.

Business Judgment Rule

The courts generally will not second-guess the directors' business judgment, even if their judgment turns out to be wrong in hindsight, provided the directors follow appropriate procedures to fulfill their fiduciary duties and duties of care in a manner that does not unfairly disregard, unfairly prejudice or oppress the interests of potential complainants.

Statutory Liabilities

In addition to their statutory duties to the corporation, directors can incur liability under a wide array of provincial, territorial and federal statutes (e.g., environmental legislation, corporate statutes, securities regulations, etc.). Typically of greatest concern to directors are their statutory liabilities for amounts that the corporation is legally obligated to pay but fails to do so. Obtaining and enhancing protections aimed at insulating directors from the brunt of these statutory liabilities is key.

Insurance Coverage

Apart from the appropriate stewardship of corporate assets and the safeguarding of protections from creditworthy third parties, the primary way to insulate directors from their statutory liabilities is through insurance coverage. There are material differences among insurance policies - one size does not suit all. Moreover, insurance polices do not necessarily afford complete coverage from potential risk. The efficacy of such coverage may be impacted by policy limits, discretionary coverage, policy administration, claims management and co-insurance arrangements. Ultimately, the nature and scope of coverage will determine the suitability of a policy in any given circumstance. Obtaining appropriate and thorough advice on insurance coverage from a qualified expert is essential.

Conclusion

Directors are well advised to re-visit corporate policies and procedures currently in place to ensure adherence to statutory and common law duties. Likewise, directors should review existing measures intended to minimize their exposure to potential statutory and common law liabilities. Process protections and insurance coverage are integral components of an enterprise risk management program designed both to ensure director corporate compliance, and to shelter directors from potential personal liabilities.