Director Independence In Canada
One of the main pillars of good corporate governance in Canada is the independence of the board. So, it should be fairly straightforward for everyone to identify what exactly is an independent director. But it is not. It depends on whose standards one uses to look at the question. It also depends on the situation in connection with which the question arises.
For "general governance," Canadian securities regulatory authorities have adopted National Policy 58-201 — Corporate Governance Guidelines ("NP 58-201") to provide public companies with guidance on corporate governance with a view to achieving the right balance between providing protection to investors and maintaining fair and efficient capital markets. NP 58-201, in conjunction with National Instrument 58-101 — Disclosure of Corporate Governance Practices ("NI 58-101") and National Instrument 52-110 — Audit Committees ("NI 52-110") set out the regulatory guidance and requirements with respect to the composition and operation of public company boards. NP 58-201 provides that boards should have a majority of independent directors and that the chair of the board should be independent. If a corporation does not have an independent chair, an independent director should be appointed to act as "lead director." The audit committee of a non-venture issuer must be composed entirely of independent directors. A director is considered independent if he or she has no direct or indirect "material relationship" with the corporation. A "material relationship" is one which could, in the view of the board, be reasonably expected to interfere with the exercise of the director's independent judgement. NI 52-110 also sets out some specific instances in which directors would be deemed not to be independent.
But in addition to the body of regulatory guidance and requirements with respect to board independence referred to above, public companies are also subject to the expectations of institutional shareholders, most notably as a result of the activities of proxy advisory firms that have their own definitions of independence and associated standards with respect to board composition. Institutional Shareholder Services Inc. ("ISS") and Glass Lewis & Co., LLC ("Glass Lewis") are amongst the most influential shareholder advisory organizations. They each set out their own corporate governance guidelines which are often different from, and even more extensive than, mandatory requirements or guidelines from the regulators. These organizations review a corporation's governance practices and advise Canadian shareholders how to vote their shares based on their standards. These firms have a strong influence on shareholder decision-making.
The media also brings its own influence on independence determinations by public company boards. In particular, companies in the S&P/TSX composite index will often seek to rank high on the Globe & Mail's Board Games Report, which is an annual ranking of the governance practices of companies forming part of such index, and this ranking is based on the Globe's own governance definitions and benchmarks, which again differ from regulatory standards.
In addition to the foregoing general governance standards, there is another different layer of independence requirements that is often confused with the foregoing general governance notion of independence. It is the concept of independence in the context of specific transactions, or in other words, the notion that a director should be free of any conflicts with respect of certain transactions rather than in respect for management. Indeed, corporate law, securities law and stock exchange rules prescribe specific requirements to ensure directors who are independent of conflicts with respect to a transaction play a special role in the approval process of such transaction. And it is not because a director is independent under the general governance standards of NP 58-201 and ISS guidelines that he or she will be independent of conflicts with respect to a specific transaction. For example a board member of company X who is independent of company X under NP 58-201 will not generally be considered independent (i.e., free of conflicts) in the context of an acquisition of company X by company Y, if the said director is also the CEO and a major shareholder of company Y.
So, in short, when a client calls a lawyer to ask if a director is independent, the client often finds the answer much more nuanced than he or she expected. There is a myriad of sources of standards that are to be considered and the context of the question (i.e., is it for governance in general or for a specific transaction) will also have an impact on the parameters that will need to be considered for the analysis.
The following is simply a matrix assembling all in one place the key definitions and standards from the various relevant sources as they relate to director independence as they may apply to a company listed on the Toronto Stock Exchange (the "TSX") in the context of (a) general corporate governance board composition; and (b) a transaction where conflicting interests for a director may arise.
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.