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Liability of Directors and Officers

Being asked to join a board of directors of a company, or act as an officer, can be a great honour, but it is also a responsibility that should not be taken lightly.  In performing their duties, Canadian directors and officers face a minefield of personal liability, arising from both legislation and common law.  This article does not purport to deal with all of these potential sources of liability, but merely: (1) provide an overview of some of the challenges facing directors and officers, and (2) offer some general advice on strategies available to mitigate their risk.

Basic Duties of Directors and Officers

In general, Canadian directors and officers must perform their duties: (1) in the best interests of the company, and (2) with a degree of care no less than that of a reasonably prudent person.  These obligations are reflected in federal and provincial statutes, such as the Canada Business Corporations Act.

In Peoples Department Stores Inc. (Trustee of) v. Wise, the Supreme Court of Canada described the duty to act in the best interests of the company (also referred to as the ‘duty of good faith’ or ‘fiduciary duty’):

The statutory fiduciary duty requires directors and officers to act honestly and in good faith vis-à-vis the corporation. They must respect the trust and confidence that have been reposed in them to manage the assets of the corporation in pursuit of the realization of the objects of the corporation. They must avoid conflicts of interest with the corporation. They must avoid abusing their position to gain personal benefit. They must maintain the confidentiality of information they acquire by virtue of their position. Directors and officers must serve the corporation selflessly, honestly and loyally.

This fiduciary duty can cause special problems in situations where a director has been elected as a representative of a specific shareholder, group of shareholders or other stakeholder (labour union, creditor etc.), as the director will likely be in a conflict of interest if they are in possession of information that affects the company, but do not disclose it to the board.

In carrying out their duties, directors and officers must act prudently and exercise their business judgment.  They are, to an extent, permitted to rely on advice that they receive from, in the case of directors, their officers and, for both directors and officers, their professional advisors, although they must not do so blindly.  In particular, they should: (1) for directors, attend board meetings (if possible), (2) make reasonable inquiries that a director or officer in the same position would reasonably make, (3) examine the financial statements of the company (when required to do so).

Mitigating Liability for Directors and Officers

Although there is no substitute for acting in good faith and being diligent, there are strategies and practices available to help directors and officers mitigate their personal liability, most importantly: indemnification from the company, good corporate governance practices and proper insurance coverage.

Where permitted by federal and provincial statutes, directors and officers should consider protecting themselves from personal liability with indemnities from the company.  Such indemnities may be set forth in the governing documents of the company (e.g. articles or by-laws) or in a separate agreement.  However, it should be noted that these forms of indemnity are limited by statute.  For example, it is not typically permitted for a company to indemnify a director or officer for any damages that arise as a result of actions performed in bad faith.  In addition, it may be appropriate to seek an indemnity from a principal shareholder of the company or other major stakeholder.

Good corporate governance practices are also important.  For example, keeping minutes of meetings which clearly demonstrate the decision making process of directors.  Board committees should adopt charters or guiding principles that are annually reviewed.  Legal advice should be sought by directors and officers where there are concerns that practices being followed may be insufficient or if there are specific questions with respect to conflicts of interest or the degree of care being used.

Insurance coverage is available to directors and officers for any liabilities which may arise, even those against which the company is not statutorily entitled to indemnify them.  However, insurers often limit such policies much in the same way as is the case in statute (e.g. exclusions for wilful acts, etc.).  Each such policy must be reviewed and negotiated to ensure that it appropriately covers the company (to the extent that it may be offering contractual or other indemnities), director and/or officer.  Often, directors’ and officers’ insurance is supplemental in nature to the indemnities offered by the company.

Timothy W. Murphy, LL.M, is a Vancouver-based business and IP lawyer.  To contact Murphy & Company, call (604) 360-7014 or email: tmurphy@murphyandcompany.ca

This article is not legal advice and is not intended as legal advice.  This article is intended to provide only general, non-specific legal information.  This article is not intended to cover all the issues related to the topic discussed.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  This article does not create any attorney client relationship and is not a solicitation.