This article was originally published in Blakes Bulletin on Litigation September 2004
In keeping with the customs of our system of law, the legal recognition of corporations and their evolution brought with it judicial decision making which cast a common law standard respecting dealings by directors and officers with their corporation.
The common law standard recognized a fiduciary duty and set a standard of zero tolerance, where no conflict of interest was to be brooked and there would be a strict accountability for any profits made by a director or officer in such a transaction. The common law has essentially been supplanted by statutory standards embodied in the governing corporate legislation. In Section 122(1)(a) of the Canada Business Corporations Act (CBCA) and Section 134 of the Ontario Business Corporations Act (OBCA), the standards are set forth as those of honesty, good faith and acting in the best interests of the corporation, and the exercise of due care, diligence and skill. The commercial reality is that business opportunities evolve through the existing contacts of directors and officers. In small markets with few players, close dealing will often represent commonplace activity. This may be reinforced by cross appointments on Boards of Directors of companies and by incentive-based compensation systems.
Full Disclosure as the Standard
Under the provisions of Section 120(1) of the CBCA and Section 132(1) of the OBCA, a statutory exception is created for non-arm’s length transactions where there is full disclosure by a director of officer who has a material interest in a contract or transaction with the corporation or a material interest in a party to a contract with the corporation. The effect of full disclosure is that the director or officer will not be accountable to the corporation or its shareholders for any profit arising out of that transaction and the contract will not be deemed void or voidable. The further proviso on this dealing is that the contract or transaction was reasonable and fair to the corporation at the time it was approved by the corporation’s directors.
Disclosure must be timely, typically for directors at the first possible directors’ meeting and for officers as soon as the officer becomes interested in a contract or aware that it will be considered at a meeting of directors. The nature of the disclosure is that it must fully inform the other directors of the "real state of things" ( UPM-Kymmene Corp.v. UPM-Kymmene Miramichi Inc.)
Further protection for officers or directors dealing with their own corporation may be obtained by having the transaction confirmed by a special resolution of shareholders provided that the nature and extent of the director’s or officer’s interest is disclosed in reasonable detail.
In circumstances relating to transactions involving a director, although the director making disclosure of his or her interest may be counted in the quorum, the director is not to vote on the matter. There are exceptions to this prohibition relating to security for credit advanced by a director for the benefit of the corporation, matters relating to remuneration, indemnity or insurance (see Section 120(5) CBCA; Section 132(5) OBCA).
Honesty, Good Faith and Reasonableness
Disclosure will not cure a transaction where the director has not acted honestly or in good faith or where the transaction was not reasonable and fair to the corporation. With respect to public companies, additional requirements apply. The TSE Company Manual in Section 609, requires approval by a majority of disinterested shareholders where a transaction requires the consent of the Toronto Stock Exchange. Furthermore, Section 5.2 of OSC Rule 51.501 details the character and extent of disclosure required with respect to related party transactions.
The remedies for the failure of due and proper disclosure in such transactions include the setting aside of the contract and accounting for any profits arising from it. The oppression remedies under corporate legislation may come into play. Proceedings may be instituted by securities regulators for market misconduct and directors can be charged with statutory offences. Furthermore, there may be collateral damage for the other directors in tort arising out of their negligence in permitting the transaction or failing to be diligent about ensuring disclosure by the transacting director and that the interests of the corporation were given due consideration.
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.
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