Article by Mary Jane Stitt, ©2005 Blake, Cassels & Graydon LLP
This article was originally published in Blakes Bulletin on Litigation - May 2005
To what extent may directors and officers who are required to participate in a regulatory investigation look to the corporation whom they serve or to its directors’ and officers’ liability policy for coverage for their legal costs? Both the Canada Business Corporations Act (CBCA) and the Ontario Business Corporations Act (OBCA) provide that a director or officer is entitled to indemnity from the corporation for all "costs, charges and expenses reasonably incurred" while participating in certain types of proceedings to which he or she is made a party or is otherwise involved because of their association with, or offices held in, the corporation.
Indemnification Under Corporate Statutes
Indemnity for investigative proceedings receives uneven treatment in the corporation statutes across Canada.
Subsection 124(1) of the CBCA permits a corporation to indemnify its directors and officers for the costs, charges and expenses that they incur in connection with investigative proceedings in which they are involved because of their association with the corporation. The OBCA standard is stricter than the federal standard of involvement. Under Subsection 136(1) of the OBCA, the director or officer must be made a party to the proceeding by reason of being or having been a director or officer of the corporation. In one case – Balesteri v. Robert – a director was considered a "party to the proceeding" where the individual was required to testify and might subsequently have charges laid against them.
Conditions for Indemnity
There are three conditions that must be met for indemnity under the CBCA (which is similar under Ontario legislation):
One. No court or other authority judged the director or officer to have committed any fault or admitted to do anything the individual ought not to have done.
Two. The director or officer acted honestly and in good faith with a view to the best interests of the corporation.
Three. In the case of a criminal or administrative proceeding that can result in a monetary penalty, the director or officer had reasonable grounds for believing that his or her conduct was lawful.
Another major difference between indemnity for directors and officers under the CBCA and the OBCA is that, under the CBCA, the corporation has the express right to advance monies to a director, officer or other individual for the costs, charges and expenses of defending a civil, criminal, administrative, investigative or other proceeding in which the individual is involved because of their association with the corporation. The OBCA does not contain a similar right to advance defence costs during the course of the litigation and before final adjudication of the charges or allegations against the director or officer.
In practice, boards of directors of Ontario corporations will have to decide whether they will run the risk of advancing defence costs, even though not expressly permitted under the legislation. The downside to any director who votes for or consents to a resolution authorizing a payment of indemnity contrary to section 136 of the OBCA is that he will be jointly and severally liable to restore to the corporation any amounts so distributed or paid and not otherwise recovered by the corporation. If an Ontario corporation elects to advance defence costs, then to protect the directors approving the advance, the corporation should require an undertaking from the indemnified director or officer to repay those costs if they ultimately do not satisfy the three statutory conditions for indemnity.
The Ontario statutory constraints can be addressed to some extent through procuring a policy of directors’ and officers’ liability insurance (a D & O Policy), although a person who receives a summons or subpoena where they are not realistically a "target" may have no recourse to either insurance or a corporate indemnity.
Directors’ and Officers’ Liability Insurance
Over the past several years, D & O Policies have been modified to expressly provide coverage for defence costs associated with participating, involuntarily, in a statutory investigation (Defence Costs). Coverage for such expenses very much depends, however, on whether the individual is a "target" or merely a witness with important information needed by the investigator to prosecute the target corporation or some other potentially culpable director, officer or employee. Note that an investigation, to be a covered Claim, must typically be of the Insured Person.
In certain policy forms, the expression "Claim" is defined as including a civil, criminal, administrative or regulatory investigation of an Insured Person once such Insured Person is identified in writing by an investigating authority as a person against whom a civil, criminal, administrative, regulatory or arbitration proceeding may be commenced or is served with a subpoena.
In the securities regulatory environment, a securities commission may not immediately begin their investigation pursuant to the enforcement section of the relevant Securities Act. For example, the Staff of the Ontario Securities Commission may elect to conduct a compliance review or continuous disclosure review under Sections 20 or 20.1, Part VII of the Securities Act, and not pursuant to Part XXII – Enforcement of the Securities Act – in reviewing and asking questions about transactions which may ultimately give rise to charges against the corporation and potentially its directors and officers. A compliance review or audit by a regulatory authority pursuant to powers other than enforcement powers may not trigger any defence or indemnity obligation under a D & O Policy even though it is obvious to everyone where the compliance review or audit might eventually lead. Consequently, even in a compliance or continuous disclosure review, a situation could exist where it may be desirable in order to protect a vulnerable director or officer for them to have their own counsel to assist them with respect to answers that they may be called upon to give regarding their conduct or disclosure. Unless a D & O insurer agrees, from a loss prevention standpoint, to cover such costs, it may not be possible to compel the liability insurer to cover the costs of counsel retained to assist individuals during a compliance review or other statutory audit process.
What Happens Once the Insurer Agrees the Investigation is Covered?
Many, but not all, D & O Policies provide that the insured is responsible for defending, subject to the funding of Defence Costs by the insurer in association with the insured. Under these "funding" types of policies, the Insured Person is responsible for appointing their legal counsel, but will require the insurer’s consent to the choice of counsel. The insurer’s concurrence with respect to the proposed hourly rates for counsel is also usually required and any significant disbursements or expenses, including the costs of retaining expert witnesses or other types of expert assistance, must generally be approved in advance by the insurer. Because of the nature of an insurance relationship, which is one of utmost good faith, insurers must act reasonably, fairly and in good faith when granting or withholding their consent concerning the choice of counsel, resources to be devoted to the defence and the defence strategy.
A D & O Policy should provide for advancement of Defence Costs on a current basis. Where the policy is silent with respect to the timing for payment of Defence Costs, which sometimes occurs, it is critical at the very outset of an investigation to strike an agreement with the insurer concerning the frequency with which legal accounts will be paid and to make arrangements for direct payment from the insurer to the legal counsel of their bills once any applicable deductible is exhausted.
For those corporations active outside Canada, particular attention should be paid to whether the D & O Policy excludes coverage for investigations or securities claims occurring outside of Canada. One should not assume that a Canadian insurer issuing a policy to a Canadian public company will automatically cover U.S. securities claims and related investigations, in the absence of specifically purchasing that coverage.
Although the major insurers participating in the D & O insurance marketplace are attuned to the changing regulatory environment and to the needs of the individual directors and officers who ultimately require the protection of their insurance products, there are still potential gaps in coverage for individuals dragged into an investigation of some other person’s conduct.
It is strongly recommended that if you are a director or officer of a public company or of a regulated institution, you develop an understanding of the protections currently available to you directly from the corporation as well as the extent to which the corporation has endeavoured to protect your interests through the purchase of a responsive and comprehensive D & O Policy.
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.