It is a reality of the late 20th century that directors and officers of companies face numerous potential liabilities. The new Act has served to emphasize this reality. Directors and officers therefore need to be very concerned about potential liabilities. Prior to the new legislation, directors already owed fiduciary duties and duties of skill and care to their companies. The legislation codifies these duties. It also reinforces and extends these duties in various ways. It is also very significant that the Act increases the range of persons to whom directors are made accountable for breaches of their duties.
The new Act describes the overriding fiduciary duty of directors as being to act honestly and in good faith and in the best interests of the company. A breach of this duty usually involves the director doing something that he should not have done at all. The Act also requires a director to exercise the degree of prudence and skill that a normally prudent person would exercise in comparable circumstances. A breach of this duty usually involves the director doing badly something that he may legitimately do.
The new Act enforces and supports these general duties owed by directors by a variety of more specific statutory provisions. For example, directors may be made jointly and severally liable for:
- authorising the issue of shares for a consideration other than money if the consideration received is less than fair;
- permitting certain transactions (such as financial assistance, share redemptions, dividends or indemnities) when there are grounds for believing that the company is insolvent;
- "oppressive conduct" by a company, its affiliates or directors.
Detailed provisions are made as to:
- the manner in which a director should disclose any interest he may have in a transaction with the company;
- the procedure by which a director may record his dissent to a decision of the Board, even when he was not present at the relevant meeting.
The Act also introduces into our law the offence of "insider trading" and provides for criminal and civil remedies. The Act substantially increases the range of persons to whom directors are made accountable. While most directors' duties are owed to the company itself, the Act provides for a "derivative action" that allows shareholders and others to sue directors on behalf of the company. In some situations, directors are made directly liable to persons other than the company. For example, in relation to insider trading, a director may be liable both to persons who suffer a direct loss and to the company for any benefit received by him. The liability faced by directors where they are found to have been engaged in "oppressive conduct" probably includes liability to shareholders, creditors and others. Even if a director is prima facie liable for breach of one of the duties imposed, there are a number of conditions and limitations imposed on liability which may provide protection in appropriate cases. For example, a director will not be liable for permitting any of the specified transactions (such as financial assistance, share redemptions, dividends or indemnities) when there are grounds for believing that the company is insolvent, if he relied in good faith upon:
- financial statements of the company represented to him by an officer of the company; or
- a report of an attorney-at-law, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by him.
The new Act has also retained a section from the former Companies Ordinance (which does not exist in the Canadian legislation and was not in the Companies Act 1995 until the recent amendments) which provides important protection to directors, officers and auditors. This allows the Court to relieve such persons from liability (wholly or partly) if they have acted honestly and reasonably and, having regard to all the circumstances, ought fairly to be excused. Provision is made for a company to indemnify directors, and to obtain insurance for them, but only in circumstances where they have acted honestly and in good faith and in the best interests of the company. In specified situations there are additional requirements for a director or officer to be indemnified, i.e.
- where his liability arises out of criminal proceedings or administrative actions that are enforced by a monetary penalty, he must also have had reasonable grounds for believing that his conduct was lawful; and
- where his liability arises out of a "derivative action", court approval for the payment of an indemnity must also be obtained.
Generally speaking, the new Companies Act merely allows a company to indemnify a director or officer against personal liabilities but does not require the company to do so. For a director or officer to require an indemnity to be given to him, there must be some positive obligation imposed on the company to provide it. In Canada it is normal for a company's by-laws to provide that it must indemnify directors and officers if the requirements of the by-laws are met. This practice should usually be followed when continuing an existing company under the new Act and when incorporating a new company. A director or officer should never assume the existence of the appropriate By-law, but should look into it and ensure that it is as broad as possible. This should be done as part of accepting an appointment and when any important change occurs, such as continuation under the new Act. If a director or officer is not satisfied, he should consider resigning. Directors and officers should also take the extra step of getting an express contractual right to an indemnity. This eliminates technical hurdles about enforcing the non-contractual By-laws. It also ensures that the company cannot unilaterally change the right to the indemnity.
There are provisions in the Act which require a company to indemnify directors and officers in specified circumstances, even where there is no By-law or contract to that effect. This right arises under the Act where the director or officer is substantially successful on the merits of the claim and the same "good faith" requirements are met. This provision reflects the fact that if substantial success is achieved, the director or officer should be indemnified.
Although insurance cover is only available subject to the same "good faith" requirements as apply to indemnities, it is advisable that it be obtained. The reason for this is that an indemnity is of little value if the company that is to provide it has become insolvent. Insurance cover is particularly useful because many instances of director's liability arise in circumstances where a company is insolvent. It is also important to note that the coverage and exclusions under a policy of insurance must be carefully reviewed, as there may be restrictions in the policy beyond the "good faith" requirements imposed by the new Act.
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.
