Canada: Focus On Corporate Governance, April 2007

The 2007 proxy season is under way and many public corporations in Canada are reviewing their current system for electing directors and contemplating a change to the traditional voting system.

Following considerable debate on the issue among issuers and institutional investors in the United States, the Canadian Coalition for Good Governance (the "CCGG") has recommended that Canadian corporations replace plurality voting with modified majority voting.¹

This system of voting is intended to allow shareholders to participate more effectively in the election of a corporation’s board of directors. At the same time, it provides the board with the flexibility to act in the best interest of the corporation and complies with existing corporate laws.

Modified majority voting is best understood by comparing it with slate plurality voting (the traditional system for electing directors of Canadian corporations), with individual plurality voting, and with "pure" majority voting.

Slate Plurality Voting

Canadian public corporations have traditionally presented a slate of nominees for election. Shareholders participating in the election have therefore had two options: either to vote "for" the proposed slate or to "withhold" their vote from the proposed slate. As long as the slate receives a single "for" vote, the presented slate is elected as the board of directors of the corporation, no matter how many votes were withheld.

Should a shareholder disagree with the proposed slate or object to the election of one nominee in particular, the shareholder must propose an entirely new slate of directors for election. This presents a significant challenge to the shareholder, who must compose an entire slate in addition to soliciting votes for that slate.

Individual Plurality Voting

Certain corporations have recognized that shareholders may wish to withhold their votes from one or more nominees without withholding their votes for directors entirely. Individual plurality voting allows shareholders to vote for individual nominees rather than for entire slates.

If a nominee receives a single "for" vote, he or she will be elected. If shareholders dislike a nominee proposed by management, they can propose a single nominee for election instead of an entire slate. In that case, the number of nominees, for which there are board seats, who receive the most "for" votes will be elected to the board of directors.

"Pure" majority voting requires nominees to receive more votes "for" than "against" in order to be elected. Since Canadian corporate laws do not allow shareholders to vote "against" a nominee but rather to withhold their vote, this approach is not available to public corporations in Canada. The goal of Canadian corporate laws on this point is presumably to avoid a failed election where no directors are elected.

Modified Majority Voting

This is the structure currently recommended by the CCGG to be implemented by public corporations. Referred to simply as "majority voting," most likely because it is the only form of majority voting that is permitted under corporate laws in Canada, it consists of the following elements which management nominees agree to abide by:

• Shareholders vote "for" or withhold their votes from individual nominees as is the case with individual plurality voting.

• Withheld votes are deemed to be votes cast against the nominee. As a result, any nominee who receives more "withheld" votes than "for" votes, though elected pursuant to the by-laws of the corporation, is required to submit his or her resignation to the elected board as this nominee would not be considered to have the confidence of the shareholders.

• The newly elected board decides whether or not to accept the resignation as soon as possible or within 90 days. The CCGG supports relying on the board's discretion to determine the best interest of the corporation.

• If the board accepts the resignation, it could then choose to leave the resulting vacancy unfilled until the next annual general meeting, appoint a new director where permitted by applicable corporate law, or call a special meeting of shareholders at which a management candidate would be presented to fill the vacant position or positions.

• Voting is done by ballot rather than by show of hands.

Most often, corporations will implement a modified majority voting system through the three following steps. First, the board will adopt an internal policy which states the elements described above.² Second,all individual nominees will be listed on management's form of proxy. Third, once a resignation is submitted, the board will decide whether to accept or reject the resignation. The board's decision should be made public in order to ensure further transparency for shareholders.

Recently, FMC assisted Tembec Inc. ("Tembec"), a leading integrated forest products company, in implementing a majority voting system. Tembec's most recent Management Information Circular describes the system that Tembec has adopted as follows:

"The board of directors has adopted a policy stipulating that if the votes in favour of the election of a director nominee at a shareholders' meeting represent less than a majority of the shares voted and withheld, the nominee will submit his or her resignation promptly after the meeting for the Corporate Governance and Human Resources Committee's consideration. The Committee will make a recommendation to the board of directors after reviewing the matter. If the board of directors' decision is to reject the resignation offer, a press release will be issued describing the reasons why the resignation was not accepted. The nominee will not participate in any Committee or board deliberations on the resignation offer. The policy does not apply in circumstances involving contested director elections."³

Modified majority voting attempts to strike a balance between plurality voting, which guarantees, unless there is a contested election, that all nominees are assured election, and pure majority voting, in which only nominees who receive a majority of "for" votes are elected. It enables directors to cautiously and responsibly increase the impact of shareholder participation in the voting process. Boards that are implementing this policy will most likely be commended by institutional shareholders for balancing the views of management and shareholders.

This newsletter is designed to supply brief details of recent case law, legislative or other initiatives of interest and some commentary. The summaries and comments provided are, of necessity, brief and should not be relied upon as legal advice.

^{http://www.ccgg.ca/best-practices/director-disclosure/}

^{http://www.ccgg.ca/guidelines/majority-voting/}

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.