Canada: SMEs, Governance And Directors

Last Updated: December 19 2011
Article by André Laurin and André Vautour

TO REMEMBER

  • The establishment of good governance practices is useful if not essential for SMEs, their directors, shareholders and managers.
  • Good governance practices can protect directors against their risks of liability.
  • Governance must be adapted to the realities of SMEs.
  • This adaptation is achieved by a combination of informal measures and a few formal measures.

INTRODUCTION

Since the mid-1990s, the promotion of corporate governance has been the subject of various public and private initiatives in Canada. The first of them were aimed at reporting issuers. State-owned corporations and other public sector organizations were targeted next.

As a result of the example provided by these corporations and pressures from funding organizations, donors and sponsors, many not-for-profit organizations (NFPs) followed behind. Similarly, in the case of SMEs not listed on a stock exchange, institutional investors and outside directors also pressured these corporations to adopt minimal governance rules.

Governance is often defined as the set of processes and systems put in place to encourage effective functioning of the corporation and the creation of value. Governance includes clearly defined mandates for the various authorities within the corporation and the formulation of expectations as regards each of them.

Note that, under most if not all corporate laws, it is the board of directors that is responsible for managing the corporation's activities; management only has delegated authority.

In Quebec, up until now, the corporate laws have not imposed specific governance rules or suggested guidelines or directives for private or unlisted corporations. Nevertheless, the absence of binding rules does not make the implementation of good governance practices in SMEs any less relevant. On the contrary, the implementation of such practices can and should create value if governance is properly adapted to the realities of the corporation and its shareholders.

In addition, the Supreme Court of Canada has noted the importance of governance for the directors with respect to their potential liability:

[64] "The establishment of good corporate governance rules should be a shield that protects directors from allegations that they have breached their duty of care." 1
(emphasis added)

This bulletin is aimed mainly at suggesting governance tools and precautions that may be used in the special context of SMEs without burdening their functioning, while protecting their directors.

SMEs' REALITIES

The reality of most SMEs is quite different from that of reporting issuers, large private corporations, public organizations and NFPs.

Most SMEs have been created by one or more entrepreneurs who in many cases are also the corporation's managers. What these managers are looking for is mainly some advice or contacts rather than supervision by a board of directors. It is usually when there are several shareholders or the corporation needs a capital contribution in the form of subscriptions for shares that the managers find themselves directly or indirectly invited to form a board that is not made up solely of family members or friends.

It is quite obvious that most of these same managers prefer to devote their energy to improving the corporation's productivity and generating sales and revenues rather than spending time preparing documents for the board and participating in meetings with the directors. Furthermore, most of the managers must already comply with certain constraints imposed on them by lenders or institutional shareholders-investors and are not particularly inclined to add to their workload.

Also, in cases where real boards are in place in SMEs, the sizes of these boards, the usual closeness of the directors to the main shareholders as well as to those who proposed them as candidates, and the financial resources of SMEs, create a different context from that of other kinds of legal persons as regards the methods and characteristics of governance.

Both governance and the way in which one takes on the responsibilities of being a director must take these realities into account.

SIMILARITY OF DUTIES AND POTENTIAL LIABILITIES OF DIRECTORS

The general duties of the directors of an SME, as well as their specific and statutory obligations are in every respect identical to those of directors of other legal persons subject, for example, to the additional obligations that are imposed on the directors of reporting issuers. Note that these duties and obligations apply to the same extent to outside directors and to directors who are also shareholders or managers. Therefore, a director-manager or director-shareholder cannot, in his capacity as a director, care about protecting only or mostly his own interests.

General duties

Thus, the directors of SMEs must comply with the following general duties:

  • act honestly and in good faith with a view to the best interests of the SME ("duty of loyalty"); and
  • act with prudence and diligence ("duty of diligence").

Liability

The rules of liability that apply to directors of SMEs are the same as those applicable to directors of other corporations. Thus, they may incur contractual liability or, as the case may be, quasi-delictual liability toward the corporation and quasi-delictual liability toward third parties if, due to their acts or omissions, they cause damage to the corporation or a third party. A breach of their duties may constitute not only a contractual fault but also a quasi-delictual fault in certain circumstances.

Moreover, the laws and regulations impose certain specific and statutory obligations and liabilities on directors, for instance:

  • toward the employees for up to six months of unpaid salaries;
  • toward the tax authorities for GST, QST and deductions at source that have not been remitted;
  • toward consumers, within the meaning of the Consumer Protection Act (Quebec), who have paid in advance for a product or service to be delivered more than two months after the entering into of the contract and that has not been delivered, if the amount of the advance payments has not been deposited in a trust account2.

Impact of unanimous shareholders' agreements

In a number of SMEs, some of the directors' powers are in the hands of the shareholders by virtue of a unanimous shareholders' agreement. However, if the directors must vote, or in fact vote, on a given issue, their potential liability remains. It also remains in cases of specific and statutory liabilities imposed by law.

RISKS OF LIABILITY

The size of the corporation, the nature of its activities and its solvency are factors that influence its risks of liability.

The corporation's risks of liability have a definite impact on the directors' risks of liability or at least on the extent of the financial consequences of a finding of liability. However, the financial and human resources devoted to governance by a large corporation are usually greater than those that an SME can allocate to it. Therefore, an outside director of an SME can find himself in a situation where the corporation does not make it possible for him to be as diligent as he would have wished or to obtain the tools and information that he should have in his possession to fulfil his duties and responsibilities. Furthermore, his compensation is usually modest compared with that of a director of a large corporation, possibly making his risk disproportionate to his remuneration received.

THE TWO CRUCIAL MEASURES

At the outset, we wish to emphasize that it is of crucial importance that an outside director:

  • make sure of the integrity of the managers, and
  • work together and closely with the other outside directors.

In fact, there are limits to what an outside director can check. Therefore, he depends in a significant way on the disclosures made by the managers of important facts that may influence the decisions that he is called upon to make. Similarly, collaboration between the outside directors enables each of them to have the same picture of the situation, the concerns, and the useful measures to recommend to management, and to make a more dynamic contribution.

A DIRECTOR'S FIVE MAIN OBJECTIVES

With a view to adequately fulfilling his duties and, by the very fact of doing so, reducing his risks, a director, and more particularly an outside director, should pursue five main objectives:

  1. have a good understanding of the corporation, its activities and its environment, validate its strategic plan and make a real contribution that creates value and contributes to the long-term survival of the corporation;
  2. make sure that the corporation complies with the law and its contractual obligations;
  3. see to it that the corporation identifies and manages its risks and prepares for changes in senior management;
  4. have a good understanding of existing and potential conflicts of interest between the various shareholders and the other stakeholders, more particularly at the time of a deal or transaction and make sure that the interests of the corporation prevail in compliance with the law and its contracts while also considering, to the extent possible, the reconcilable interests of the stakeholders (shareholders, employees, customers, suppliers, governments, communities ...) and favouring equitable treatment of these stakeholders;
  5. protect himself against the risks of personal liability, more particularly as regards the specific sources of liability under the law (unpaid salaries, failure to remit deductions at source, GST or QST, etc.) by obtaining for this purpose, among other things,

    • certificates of compliance from management;
    • liability insurance coverage;
    • indemnification undertakings both from the corporation and one or more shareholders;

and, in the event of financial difficulties or insolvency, by tightening up the supervision of management, by increasing the frequency of certifications, by obtaining indemnification undertakings from one or more shareholders and by requiring from the trustee and, if need be, from the court, maximum available protection under the laws concerning insolvency or bankruptcy or, in the absence of adequate protection, by resigning.

INFORMAL MEASURES

In the case of SMEs, the informal measures take on more importance than in the case of large corporations and can make up for, at least in part, an insufficiency of formal measures, and thus attain an adequate level of governance.

So, an external director has an interest in:

  1. visiting the corporation's facilities, and talking occasionally with its key employees and its main customers and suppliers;
  2. meeting individually and regularly with the president and the other main managers and, on these occasions, for example:

    1. pro-actively seeking information about the managers' concerns and projects;
    2. in the case of important planned transactions, asking questions about the reasons justifying such planned transaction, the other hypotheses that have been eliminated and the expected return on the investment;

  3. passing on documents, information, references and ideas to the president, as well as the names of useful persons to whom he could introduce the president;
  4. talking regularly between meetings with the other external directors, to exchange with them the information gathered on all sides from the managers, customers, suppliers and third parties, and to discuss their respective concerns;
  5. informing himself regularly about the corporation's field of activities, including information concerning its competitors and market realities and prospects;
  6. preparing, with the other outside directors, a list of persons who could eventually replace the senior managers, if need be, as well as a list of potential buyers or strategic partners, and keeping these lists up to date so as to be ready to propose other working hypotheses to be studied in view of possible recommendations by management concerning these subjects; and
  7. suggesting candidates for directorship, with whom he could work effectively.

CERTAIN FORMAL MEASURES

In addition to the certifications discussed above, certain simple measures can establish a way of operating that promotes the work of external directors.

We wish to mention, among others,

  1. the use of an external director as the chairman of the board or, at least, as the chairman of the meetings;
  2. the use of a corporate secretary or a secretary of the meeting, who takes notes of the deliberations and prepares the minutes;
  3. the adoption of a model agenda (follow up on previous decisions or matters arising therefrom, certificates and declarations from management, reports concerning certain subjects such as workplace accidents, the environment...) that facilitates proper supervision of management's activities, but above all the expression of questions and comments by the directors and real discussion of important issues;
  4. the communication to management prior to each meeting of the subjects that the external director wishes to have included on the agenda;
  5. the use of requests to management to invite certain managers and/or outside advisors (lawyers, accountants and other specialists) of the corporation to attend certain meetings of the board and asking them appropriate questions during the meetings to obtain the desired confirmations;
  6. during the meetings, the making of a statement by an outside director of his understanding of the information gathered from the president or other managers at the time of prior informal meetings, followed by a request that the president and other managers confirm the correctness of such understanding;
  7. the use of requests to note in the minutes the content of such understanding as validated by the president and the answers of both the managers and the outside advisors of the corporation obtained during the meetings or informally;
  8. the obtaining and study of important contracts before approving them;
  9. the use of requests for and the obtaining of, both regularly and in a more targeted way at the time of an important transaction or contract, confirmations by management concerning compliance with the law and the absence of conflicts of interests or false declarations, and of recommendations and advice from outside experts in these respects;
  10. the adoption and monitoring of framework policies (for example: psychological harassment policy, code of ethics, etc.) and control systems;
  11. the holding of meetings of the directors outside the presence of management; and
  12. the obtaining of the certificates, insurance coverage and indemnification undertakings described above in the context of objective No. 5 in the section "A director's five main objectives" of this bulletin.

Many of these suggestions are aimed in particular at replacing the studies and reports that the managers of large corporations prepare and provide to their boards of directors and at enabling the directors to demonstrate that they are acting with reasonable diligence in the performance of their duties.

INTEREST OF THE SHAREHOLDER-MANAGER IN PROMOTING GOOD GOVERNANCE

A shareholder-manager can derive substantial benefits from the establishment of good governance practices.

The following are some non-exhaustive examples:

  • the corporation of which he is a manager will probably be able to increase its credibility in the eyes of lenders and investors;
  • he will be able to recruit better individuals to become directors;
  • in the event of the sale of the business, potential purchasers will be less fearful;
  • as a director, he will increase his own protection with respect to his potential liability;
  • the corporation's risk of being sued will be reduced;
  • these governance practices will force him to be more systematic and to develop more effective monitoring tools and control systems;
  • but, above all, he will benefit from help and valuable advice from his co-directors.

These benefits, among others, should tilt the scales in favour of the implementation of good governance practices.

Note that the ability of a manager to listen to and accept criticism is recognized as one of the major skills of a true leader.

Moreover, the fears that a shareholder-manager may have should be quickly eliminated by the power that he may hold, in many cases, in his capacity as a shareholder (quite often the majority shareholder), including the power to change the make-up of the board of directors (not re-electing directors or even removing them at a special meeting of the shareholders held for that purpose).

CONCLUSION

One must never forget that under the laws governing corporations, it is the board of directors that has the responsibility to manage the corporation and that delegation to the managers does not relieve the board of directors from its responsibility in the last resort in many cases.

It is therefore important that a director of an SME finds the means to fulfil his duties and to play his part fully, but above all that in practice he fulfils his responsibilities adequately with the primary objective of creating value.

Both the shareholders and the managers and directors have an interest in implementing good governance practices adapted to the realities of their SME.

Footnotes

1 Peoples Inc. v. Wise [2004] 3 S.C.R., 471.

2 However, defences may be available.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
André Laurin
 
In association with
Related Video
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Law Practice Management
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.