Canada: Duties And Liabilities Of Directors And Officers

First presented at a Client D & O Seminar

Introduction

Directors and officers, acting as a manager of a corporation, have a number of duties and responsibilities that they are required to carry out. These duties are largely set in place to protect the interests of shareholders and other individuals who are not shareholders but nevertheless have a stake in the corporation, such as creditors.1 While most of these duties were established at common law, the majority of Canadian jurisdictions have codified them.2 Often times, if these duties are not met directors and officers will be personally liable. A finding of liability will often result in remuneration to the corporation.

The following paper will outline the main duties that directors and officers have. Further the following article will examine the liability that will ensue for the breach of such duties.

Fiduciary Duty

Directors and officers owe a fiduciary duty to the corporation.3 This is a "standard of behavior" that is expected of a director and officer with regards to their dealings or interactions with the corporation.4 This duty can be found in section 122(1)(a) of the Canada Business Corporations Act ("CBCA"):5

122 (1) Every director and officer of a corporation in exercising their powers and discharging their duties shall

(a) act honestly and in good faith with a view to the best interests of the corporation

This often entails that directors and officers refrain from placing their own interests before that of the corporation. Typically, where this duty is breached the director or officer gains a profit "at the expense of the corporation".6 As such, the main remedy provided by the courts is to ensure that the director or officer is held to account for his or her profits to the corporation.7

It is important to note that when a court is examining the actions of directors or officers they will often employ the "Business Judgement Rule". This refers to instances where the court acknowledges that they are not experts in business and instead the court will show deference to the corporation.8

Issues surrounding breaches of fiduciary duty often arise where: (a) the director/officer transacts with the corporation, (b) the director/officer takes opportunities away from the corporation, and (c) where the director/officer competes with the corporation. Each of these will be explored in turn.

(a) Transacting with the Corporation

This scenario is often seen in the situation where a director or officer sells goods or services to its corporation. As the seller of the goods, the director strives to sell its product for as much as it can. However, as the director of the corporation, that individual has an obligation to get the goods or services at the lowest possible price.9 Due to this inherent conflict, these transactions were traditionally considered voidable, regardless of whether the deal struck between the parties was a fair one or not.10

However, in an attempt to lax this universal prohibition, the CBCA has been modified to allow for certain transactions between the corporation and its directors or officers.11 In particular, these transactions are allowed where:

  1. the director or officer provides the corporation with written notice, which must be evidenced in the minutes of a directors meeting,
  2. the transaction must be approved by the shareholders or directors of the corporation, and
  3. the transaction has to be "fair and reasonable to the corporation".12 Where directors or officers are able to meet these three requirements the transaction is permissible.

In cases where these three requirements are not met, the CBCA offers an alternative saving provision. In particular, the contract can still be enforced if: (1) the interest of the director or officer was disclosed to the shareholders of the corporation in "sufficient detail", (2) the contract received approval by way of special resolution of the shareholders, and (3) that the contract was "reasonable for the corporation at the time it was approved".13

If these requirements are not met, then the director or officer has breached their fiduciary duty. As such, the court may either set aside the deal or require the individual to account to the corporation for his or her profits.14

It is important to note that the provisions in the articles or bylaws of the corporation "permit" these dealings are not effective [(OBCA s. 134(3), CBCA s. 122(3)].15 Further, the corporation or its directors are not allowed to set an "easier" standard for fiduciaries than the one found in the statute.16

(b) Taking Corporate Opportunities

Another scenario where issues surrounding fiduciary duty arise is where the director or officer takes a corporate opportunity away from the corporation. This generally occurs where the director or officer invests in a project or opportunity that the corporation also has an interest in.17 The court in Cook v Deeks held that a corporate opportunity "belongs" to a corporation where that corporation is "actively seeking an opportunity".18 In Canadian Aero Service Ltd. v O'Malley, the Supreme Court of Canada formulated a test to determine if seizing a corporate opportunity constitutes a breach of fiduciary duty.19 The first part of the test requires determining the closeness of the opportunity to the corporation.20

A list of non-exhaustive factors to consider in determining the proximity between a corporation and a particular opportunity include: (a) maturity of opportunity, (b) specificity of the opportunity, (c) significance of the opportunity, (d) whether the opportunity was private or public, and (e) whether the corporation rejected the opportunity.21 The second part of the test requires an examination of the relationship of the fiduciary to the opportunity.22 This involves looking at (a) the connection between the fiduciary's responsibilities and the opportunity, (b) whether the knowledge of the opportunity was acquired as a fiduciary, (c) whether the fiduciary used his or her role to get the opportunity, and (d) whether and when the opportunity was rejected by the corporation.23

Once the test has been applied to the facts at hand and if both the corporation and the fiduciary have a close relationship to the opportunity, then the appropriation of that opportunity by the fiduciary is likely to constitute a breach of duty.

(c) Competing with the Corporation

The fiduciary duty that directors and officers have to a corporation does not permit them to compete with the corporation.24 However, the fiduciary is able to resign from their positon and then compete. It is important to note that the director or officer cannot use his or her position as a fiduciary to obtain opportunities and then quit and capitalize on those opportunities.25 If the fiduciary duty competes with the corporation, a court will likely require that he or she pay over the profits earned from the competition back to the corporation.

Duty of Care

In addition to the fiduciary duty owed to the corporation, directors and officers also owe a duty of care. This duty is found in section 122(1)(b) of the CBCA:26

122 (1) Every director and officer of a corporation in exercising their powers and discharging their duties shall

(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

There is some debate as to whether the duty of care is owed only to the corporation or to other stakeholders as well.27 However, the answer seems to be related to how the corporation was incorporated. In particular, if the corporation was incorporated under the Ontario Business Corporations Act ("OBCA") then the duty is owed only to the corporation.28 However, if the corporation was incorporated under the CBCA, the Supreme Court of Canada has held the duty of care is a general standard of behavior and it is owed to all the corporate stakeholders, such as creditor and shareholders of the corporation.29

The content of the duty of care owed by directors and officers includes a number of elements. First, the statutory duty requires that directors and officers have a minimum standard of competence.30 This entails a rudimentary knowledge of business.31 Second, to meet the duty of care, there is a degree of monitoring that is expected of directors and officers. This typically means that the director or officer has to keep himself or herself appraised of the general affairs of the corporation.32 This entails being familiar with the financial status of the corporation by way of reviewing the financial statements regularly.33

Unlike some of the other obligations of the directors and officers, the duty of care cannot be delegated.34 Further, the duty of care is an objective standard. However, it has a contextual (subjective) element due to the referral to "comparable circumstances".35 Finally, the standard of care is higher for directors who are also officers of the corporation.36

Liability for Unpaid Wages

In cases where the corporation becomes bankrupt or is involved in liquidation, directors are liable to its employees for up to six months of wages.37 However, the employee must be cognizant of a number of timelines. In particular, if the employer brings an action six months after the payments were required, then directors are not liable.38 In cases involving bankruptcy, the claim for unpaid wages has to be substantiated with six months of the bankruptcy.38 Finally, where the corporation is going through a liquidation or dissolution proceeding, the unpaid employer must prove his or her claim within 6 months of the commencement of proceedings. Moreover, a director's liability for unpaid wages expires two years after he or she is no longer a director.

Employees legally entitled to work in Canada are afforded protections under the Wage Earner Protection Program (WEPP) Act. This program provides payments of wages, vacation, severance, and termination pay that are owed to eligible workers, up to an amount equalling four weeks' of maximum insurance earnings under the Employment Insurance (EI) Act. 40

An employee that is terminated and is owed unpaid wages is required to file a proof of claim with the trustee or receiver as soon as possible after their employer has filed for bankruptcy or is subject to a receivership. In terms of the quantum of payments, WEPP payments to terminated employees are reduced by any amount paid to them after the date of bankruptcy or receiver. These payments are also subject to an offset (reduction) in the amount of 6.82% as required by the WEPP Regulations.41

When an employee applies for payments from WEPP, he or she agrees to allow the Government of Canada to subrogate their claim, up to the amount of the payment received from the Program. The Government will attempt to recover the amount it has paid under the program from the estate or property of the insolvent employer at the time the assets are distributed through the bankruptcy and receivership process.

Restrictions on the Use of Corporate Funds

There are a number of restrictions placed on directors with regards to the use of corporate funds. In particular, before a director can distribute money to the shareholders of the corporation the directors have to meet a number of requirements. Money is distributed to shareholders for a number of reasons such as: (a) payment of dividends, (b) share redemption or repurchase, and (c) even when paying shareholders for remedies (i.e. dissent and appraisal).42

Prior to any form of payment is made to shareholders, the directors must ensure that they meet two financial tests. First, the solvency test must be met. This ensures that the corporation is solvent at the time the payment is made. Meaning, the corporation is able to meet its liabilities as they come due.43 The second test the directors must meet is the capital impairment test. This test requires that that prior to any payment being made, the realizable value of a corporation's assets are at least equal to the sum of its liabilities.44 The rationale on these restrictions is that payment should not be made to shareholders where it would be prejudicial to the creditors of the corporation.

If payment is made to the shareholders without the director being satisfied, based on a reasonable belief standard, then the director will be personally liable to the creditors for that amount owed.45

Directors and officers have a number of duties as managers of the corporation. The main duties they have include: fiduciary duty, duty of care, they are responsible to a certain amount for employees unpaid wages and finally, there are a number of obligations they have with regards to the use of corporate funds. The major theme of these duties or obligations is balance the needs of the corporation with their own interests and to balance the interests of the shareholders as against the creditors of the corporation. The liability that ensues for breach of these duties is often in the form of remuneration which often takes the incentive to breach these duties away.

Footnotes

1 Anthony J VanDuzer, The Law of Partnerships & Corporations, 3rd ed (Toronto: Irwin Law Inc, 2009) at pp. 338-339.

2 Ibid at pp. 339..

3 Ibid.

4 Ibid at pp. 340.

5 Canada Business Corporations Act, RSC 1985, c C-44 at s. 122(1) (a). ["CBCA"].s

6 Supra note 1 at pp. 341.

7 Ibid.

8 Ibid at pp. 344.

9 Ibid at pp. 345.

10 Ibid.

11 Ibid at pp. 346.

12 Ibid at pp. 349-350.

13 Ibid at pp. 350-351.

14 Ibid at pp. 351.

15 Ibid.

16 Ibid.

17 Ibid at pp.352.

18 Ibid at pp. 353.

19 Ibid at pp. 356-357.

20 Ibid at pp. 356-360.

21 Ibid.

22 Ibid.

23 Ibid.

24 Ibid at pp. 362-363..

25 Ibid.

26 Supra note 5 at s. 122(1) (b).

27 Ibid at pp. 375.

28 Ibid.

29 Ibid.

30 Ibid at pp. 378.

31 Ibid at pp. 379.

32 Ibid.

33 Ibid.

34 Ibid at pp. 382.

35 Ibid at pp. 381.

36 Ibid at pp. 382.

37 Ibid at pp. 385.

38 Ibid.

39 Ibid.

40 Government of Canada, Wage Earner Protection Program (WEPP), (Labour Program)

41

Ibid.

42 Supra note 1 at pp. 386.

43 Ibid.

44 Ibid at pp 386-387.

45 Ibid at pp 387.

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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