The Business Corporations Act (Ontario) "OBCA" and the Canada Business Corporations Act set out requirements for directors and officers in cases of conflict of interest. This article highlights the key steps directors and officers must take to insulate themselves from personal liability.
In cases of conflict of interest, non-compliance with disclosure requirements can result in any or all of three consequences:
- the contract or transaction entered into can be declared voidable at the will of the corporation;
- the director or officer can be held accountable to the corporation or shareholders for any profits realized from the transaction; and
- if the directors act without reasonable cause, they can be found guilty of an offence punishable on summary conviction.
A) Is There a Conflict of Interest?
A conflict of interest exists if a director or officer has a material interest in a proposed or established material contract or transaction of the corporation.
A transaction is material to the corporation if it would affect a reasonable investorrs decision to buy or sell securities in the corporation. A directorrs interest is determined to be material if the disclosure of the interest would be a relevant factor in the decision of the corporation to enter into the transaction. A material interest could include a direct monetary interest or an indirect interest such as a close relationship with a beneficiary of the transaction. It is recommended that directors include a written statement in their resolution or minutes indicating whether or not they believe a certain transaction is material to the corporation.
It is important to keep in mind that the term transactionn is broad and extends to matters beyond contracts. For example, payment of dividends would be considered a transaction.
B) Checklist of How to Comply with the Statutory Disclosure Requirements
1) Written Disclosure
Disclosure can be given to the corporation in writing or by requesting to have it entered in the minutes of the directors' meetings. It is not sufficient for the conflict to be obvious on the face of the transaction, or for all the other directors to be aware of the conflict. The statute specifically requires that there must be written evidence of the disclosed interest.
2) Amount of Disclosure Required
The disclosure must include the nature and extentt of the directorrs or officerrs interest. Disclosing that a certain director or officer has an interestt may not be enough to comply with the statutory requirements. All information that is or may be relevant to the corporationns decision on whether or not to enter into the contract must be put forth in writing. The amount of detail required depends on the nature and context of the transaction. Since there is uncertainty as to how much detail will satisfy the statutory requirement, it is advisable to err on the side of inclusion and include as much detail as possible.
Directors and officers must disclose their interest in a transaction or potential transaction the moment they learn of it. Disclosure must also be made continuously if a director subsequently becomes interested in the transaction or an individual who has an interest becomes a director. In either event, disclosure must be made at the first available opportunity.
It is important to note that if a transaction was entered into during the ordinary course of business and did not require directorss approval, the directors are still obligated to disclose their interest as soon as they become aware of the transaction.
A director who has a conflict of interest cannot vote in any resolution involving the transaction in which they have an interest. Interlocking directors and officers who serve in affiliate companies are an exception to this rule. They may vote so long as their interests are properly disclosed.
Previously, a director who had a conflict was allowed to vote on contracts relating to his or her own compensation as a director, officer, employee or agent. However, on August 1, 2007, the latest amendments to the OBCA came into force, one of which narrowed this exception. Now, a director can vote on his or her own compensation as a director, but not on his or her compensation as an officer, employee or agent.
A director who had a conflict was previously allowed to vote on transactions involving grants of security by the corporation to a third party for obligations undertaken by the director for the benefit of the corporation. The amendments to the OBCA repealed this exception.
It is recommended that the resolution or minutes of the meeting explicitly note who is and who is not eligible to vote due to a conflict of interest.
In the case of interlocking directors or officers of affiliate companies, it is possible to issue a general notice of interest that will satisfy the disclosure requirement. These types of notices should be used cautiously as they are intended to apply only to a limited number of situations of continued transactions with the same party. They do not apply in cases where a director or officer has a direct interest.
The OBCA amendments require directors who rely on the general notice of interest to notify the corporation of any material changes in the nature of their conflict of interest.
5) Attending Directorss Meetings
Under the OBCA amendments, where a director is prohibited from voting on a resolution due to a conflict of interest, the conflicted director is also prohibited from attending the portion of a meeting during which the transaction at issue is discussed.
If quorum is not achieved at a directorss meeting due to conflicts of interest, the amendments to the OBCA provide that the remaining directors shall be deemed to constitute a quorum for the purpose of voting on the resolution in question. If all of the directors have a conflict of interest, then only the shareholders can approve the transaction.
6) Fair and Reasonablee Transaction
The transaction must be fair and reasonablee to the corporation at the time it was entered into. If the transaction is one-sided and not to the benefit of the corporation, the transaction will be invalid and the director runs the risk of exposing him- or herself to liability for non-compliance.
7) Written Resolutions of Directors
As discussed above, a director with a conflict of interest cannot vote on any matter in which he or she is conflicted. However, where a resolution is to be passed by way of written directorss resolutions, the conflicted director may not abstain, as corporate law requires that written resolutions be signed by each director entitled to vote, that is, excluding the conflicted director. The conflicted director must disclose his or her interest. The resolution must be signed by the remaining, non-conflicted directors, and then the resolution of the conflicted director must be ratified and confirmed by the shareholders.
8) Directorss Duties May Continue Even After Resignation
In addition to the statutory disclosure requirements, directors must also comply with duties imposed by case law. Canadian courts have held that when directors or officers learn about a business opportunity by virtue of their role with the corporation, that opportunity belongs to the corporation. If officers and directors appropriate a business opportunity, they have a conflict of interest, even if they resigned from the corporation after learning about it, and even if the corporation is unable to capitalize on the opportunity. Officers and directors are able to take advantage of business opportunities only in very limited circumstances, for instance, when the corporation has not invested any effort in developing the opportunity, and the corporation rejects the opportunity in good faith and for legitimate business reasons.
C) Reward for Compliance
If the requirements of the statute have been fully complied with and the corporation approves the transaction, the director will have taken important steps towards successfully insulating him- or herself from personal liability. Directors must remember their foremost duty to act in good faith and in the best interest of the corporation. Complying with the disclosure requirements will not shield directors and officers from liability if they place their own interests ahead of those of the corporation in situations of conflict of interest.