Every director of a corporation, regardless of whether it is a publicly traded corporation or a closely held private corporation, is subject to a common law fiduciary duty to act loyally and in the best interests of the corporation.
In Ontario, that common law duty is codified in Section 134(1) of the Ontario Business Corporations Act. The Act obliges every director and officer 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 exercise in comparable circumstances.
The duty to act in the "best interests of the corporation" means that directors must act in the interest of the corporation as a whole, rather than in the interest of any particular shareholder or group of shareholders. The best interests of the corporation are usually the same as the best interests of the shareholders as a whole, but in some cases acting in the best interests of the corporation could require that a director act other than in the interests of a particular shareholder.
General Test For Satisfaction Of Directors' Fiduciary Duty
If directors exercise reasonable care when making a decision, the Courts will generally not hold them liable for simple errors of business judgment that they may make in the management of the corporation. Traditionally, the Courts have been reluctant to second guess the manner in which the directors have exercised their discretion. In fact, in the absence of evidence to the contrary, the law presumes that directors have acted on an informed basis, in good faith and with a view to the best interests of the corporation.
The case law indicates that directors will not be subject to personal liability for bad business decisions provided that the following three requirements are satisfied:
- the directors informed themselves as to the relevant facts needed to form a business judgment before making their decision;
- they acted in good faith, in accordance with law, and in accordance with their duty to act in the best interests of the corporation; and
- their decision appears to have had a rational basis at the time when it was made.
Both the Ontario and the Canada Business Corporations Act contain provisions that allow corporations in certain circumstances to indemnify directors and to purchase and maintain liability insurance for the benefit of directors who incur liability in their role as a director. However, the legislation prohibits corporations from indemnifying directors, or from maintaining insurance to cover situations, where "the liability relates to the (directors’) failure to act honestly and in good faith with a view to the best interests of the corporation".
The American cases suggest that the directors’ actions may be considered to be a breach of the duty of good faith where the directors "consciously and intentionally disregarded their responsibilities, adopting a ‘we don’t care about the risks’ attitude concerning a material corporate decision’ (in re The Walt Disney Co. Derivative Litigation).
The Duty To Avoid Conflicts Of Interest
Under Section 132 of the Ontario Business Corporations Act, directors must disclose conflicts of interest. A director must disclose in writing to the corporation where he or she is a party to, or is a director or officer of, or has a material interest in, any person who is a party to, a material contract or transaction or proposed material contract or transaction with the corporation. In addition, directors with such an interest are prohibited from voting on any resolution to approve the contract or transaction (except for some specific exemptions).
Where directors fail to comply with this requirement, the corporation or a shareholder of the corporation may apply to the Court to set aside the transaction and to direct that the director account to the corporation for any profit earned from the transaction.
The prohibition against conflicts of interest can sometimes create difficulties for nominee directors who are appointed by a specific shareholder, especially where the appointing shareholder does business in the normal course with the corporation. The Nova Scotia Court of Appeal specifically considered that issue in the case of Keating v. Bragg, and the Court held that "the mere fact that a director is a nominee of a majority shareholder in itself does not disentitle the director to vote at a properly convened meeting of the board of directors to consider a contract in which the majority shareholder has an interest".
However, the Nova Scotia Court of Appeal did make it clear that, "a director’s duty is to vote in accordance with what is in the best interest of the company and in a manner that is not oppressive to the interest of a minority shareholder in the company."
The Prohibition Against Insider Trading
Illegal insider trading involves trading a security while in possession of undisclosed material information about the issuer, and includes related violations such as "tipping" information.
Securities legislation in Canada prohibits any person or company in a "special relationship" with a "reporting issuer" (essentially, a public company) from purchasing or selling securities of that company with the knowledge of an undisclosed material fact or material change. That person is also prohibited from informing any other person or company of a "material fact" or "material change" before it has been generally disclosed ("tipping").
A person in a "special relationship" includes a person who is a director, officer or employee of the reporting issuer. It is often a difficult task to assess whether information is material. The question of materiality is usually litigated with the benefit of hindsight. People in a "special relationship" including all directors, should assume that information is material if an investor might consider the information to be important in deciding whether to buy, sell or hold securities. Securities legislation also imposes an obligation on senior corporate individuals, including directors, to report their trading in securities of the relevant reporting issuer. Under the new Multilateral Instrument, this now extends to include reports on derivative-based transactions, such as equity monetization, by which insiders can, for example, divest themselves of their economic interest in a security without trading in that security itself.
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.