Canada: "Eyes Open, Nose In, Fingers Out": Understanding And Managing The Potential Risks Of Signing On As A Corporate Director

Acting as a corporate director can be a highly energizing and rewarding experience, whether it's for a publicly traded company, a private company, or a not-for-profit or charitable organization. Before signing on, however, some potential risks must be considered and addressed.

Up Front Due Diligence

As a starting point, it is essential for a would-be director to research and understand the nature of the underlying business, who is running it, and their track record in the industry.  Start by checking the company's website, googling their current directors and executives, reviewing a public company's filings on SEDAR and checking stock price history for significant swings or an extended period of trading at a low price. Directors can be liable for unpaid wages and unremitted source deductions, so it is critical that there is evidence that the company has been and will continue to be able to pay its liabilities as they come due. Review financial statements and ask questions about the number of employees and their location. If the nature of the business might involve health and safety or environmental issues, request copies of the relevant company policies, as both of these areas can give rise to personal liability for directors.

Indemnities

While indemnities offer some level of protection to directors, they should work in tandem with insurance policies, and the two should not be thought of as mutually exclusive. Typically the by-laws of a corporation will provide for indemnification of directors and officers. However, it is generally advisable to request a separate indemnification agreement in addition to the indemnity contained in the by-laws. First, a separate indemnity agreement creates privity of contract between each director and the company, and along with that comes the right to enforce the contract. In addition, apart from the uncertainties surrounding the ability of directors to enforce compliance with by-laws, by-laws may be amended to remove indemnification obligations to the detriment of former directors.

While the by-law indemnity is likely silent in respect of insurance obligations of the company and therefore subject to the ability of the company to fund the indemnity, a director should be able to negotiate a clause in the indemnification agreement that will require the company to maintain D&O insurance in favour of the director for a period of time following the date on which the director retires, resigns or is no longer a director of the company.

Insurance

It is also essential to gain an understanding of the insurance available to protect directors and officers in the exercise of their duties. Inquire as to the program limit on the company's D&O insurance policy, and consider if that limit is appropriate for the profile of the risk. Ask who the insurers on the D&O program are, and what their financial strength ratings are. Find out if there have been any recent claims or notifications of circumstances which might give rise to claims reported on the current D&O program. Find out specifically if the company has purchased Side A Difference in Conditions coverage, which provides coverage directly to directors and officers, and the limits of which are not shared with the company. This type of coverage is placed in conjunction with traditional D&O insurance. It is purchased by the majority of public companies and is becoming increasingly purchased by larger private and not-for-profit organizations.  

It would be a good idea to ask for a copy of the D&O policy and have it reviewed independently. It may also be important to find out what other insurance coverages, in addition to the D&O insurance, have been purchased by the company, including the types of coverage and applicable limits. This is important to know because directors are typically insureds on other insurance policies that provide coverage for items commonly excluded by a D&O policy, such as bodily injury and property damage, pension benefits liability, etc. 

Protection Through On-Going Good Governance

While indemnities and insurance provide protection in case things go wrong, there is no substitute for the value of good corporate governance in minimizing risk. There are a number of steps board members can take to ensure they are on top of the risks facing both the Company and the directors. First, understanding the duties and liabilities of directors is essential, and can easily be achieved through attendance at seminars on the topic and joining organizations like the Institute of Corporate Directors. Familiarize yourself with the constituting documents of the company – their articles of incorporation, by-laws and any shareholders agreement to ensure you are aware of the basic framework within which management is permitted to operate. If the company does not have a board mandate or board committees in place, take steps to enhance the corporate governance policies and put in place at the very least an audit committee and if possible, an HR and compensation committee. Each committee of the board should have a work plan in place, and report to the board regularly.  Having management report to the committee using pre-set checklists helps to ensure directors are discharging their duties of oversight with their "noses in, fingers out". These tools help you to ensure that management is considering the various areas of risk to the company and is addressing them on a regular basis. To the extent there are areas of non-compliance, the rectification of those issues can be tracked easily by reviewing their status on a regular basis.

Most importantly, ask questions of management and encourage them to bring additional expertise in to board meetings to report on the status of various areas of risk.

Taking these steps will ensure that the risk of board membership is managed effectively, allowing directors to get the most out of their board experience.

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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