Protecting Yourself as a Director – Directors’ Duties and Liabilities

Updated: Feb 17



By: David Kim | February 15, 2021


What potential liabilities do I face as a director on a company board, and how do I protect myself?”


This is one of the most frequently-asked questions that I get asked in my corporate law practice. It is an important question and one which deserves meaningful discussion and dialogue.


Often times, individuals who are asked to join a company board do not give adequate thought and consideration to the duties and liabilities which accompany such a role.


The rewards of joining a board are many – involvement in significant business decisions, networking with fellow business leaders, prestige, etc. However, the benefits are not without risks, which present themselves in the form of potential liabilities that directors may face in performing their roles.


This article will provide an overview of directors’ duties and liabilities and set out certain protective measures directors may take to shield themselves against potential liabilities.


Directors’ Duties


A director on the board of directors of a corporation owes two central duties to the corporation. The first is a duty of loyalty, and the second is a duty of care.[1]


The duty of loyalty requires a director to act honestly and in good faith with a view to the best interests of the corporation. For instance, a director must not place her personal interests above those of the corporation when exercising her powers as a director.


The duty of care obliges a director to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. This duty requires a director to make reasonably informed decisions by considering all material and relevant information. Directors must be diligent in supervising and overseeing the corporation’s affairs.


Directors’ Liabilities


Directors are exposed to a wide range of potential regulatory, criminal and civil liabilities, which can include industry-specific regulatory liabilities, taxation liabilities, environmental liabilities, and liabilities associated with companies in bankruptcy, insolvency or receivership.


This article will not examine the above-mentioned liabilities, but it will instead focus on the potential liabilities that all directors face under federal and Ontario corporate law statutes – namely, the Canada Business Corporations Act (“CBCA”) and the Business Corporations Act (Ontario) (“OBCA”).


1. Compliance with Statutory Duties


A director has a duty to comply with (1) the governing corporate law statute, which includes the duty of loyalty and the duty of care, and (2) the constating documents of the corporation, including its articles, by-laws and any unanimous shareholders agreement.[2] A director who fails to comply with this statutory requirement may be found guilty of a statutory offence, and, if found guilty, could be punished with a fine and/or imprisonment.[3] A failure to meet these duties may also result in civil liability – i.e., lawsuits commenced by related parties or third parties.


2. Unpaid Wages of Employees


Directors may be held liable to employees of a corporation for all debts not exceeding six months wages payable to each such employee for services performed while they were directors.[4]


3. Issuance of Shares


A company must receive “fair value” for any shares it issues for consideration of property or past services. If a director consents to the issuance of shares for consideration of property or past services at a value (e.g., $150,000) below the fair equivalent of the money that the corporation would have received for the issuance of such shares (e.g., $200,000), the directors may be held liable to the corporation to make good for the difference of such amount (e.g., $50,000).[5]


4. Payments to Shareholders


A corporation may make payments to its shareholders under the following scenarios: (1) payment of dividends, (2) repurchase of shares, or (3) redemption of shares. However, the corporate statutes prohibit a corporation from making such payments to shareholders if there are reasonable grounds to believe that the corporation is insolvent or close to insolvency.[6]


If a director approves such a payment to a shareholder contrary to such prohibition, the director may be liable to restore to the corporation any amounts paid by the corporation which have not otherwise been recovered by the corporation.[7]


Protective Measures to Mitigate Against Directors’ Liabilities


Fortunately, for directors, there are several ways in which they can protect themselves from the risks and liabilities associated with serving on a company board. These protective measures can be taken pre-emptively – i.e., prior to accepting a director role – and on an ongoing basis. Potential and existing directors should be aware of the protective measures at their disposal.


1. Exercise Due Diligence


In the decision-making process and in carrying out directors’ duties, a director must exercise due diligence. This means making decisions on an informed basis – conducting the investigation, research and analysis that meet the statutory standard of care. Some examples of exercising due diligence include: (1) asking relevant questions of company management, (2) relying on third-party expert reports (financial, legal and technical), and (3) receiving the advice of independent legal counsel, if necessary. The reliance on experts for matters in which the board lacks expertise could serve as a defence against liability, in and of itself, and also establish a due diligence defence.[8]


2. Access to Information


A director should request access to all pertinent information when a decision is being made by the board of directors. This information should be made available on a timely basis in order to allow for proper consideration of all relevant factors and issues.[9]


3. Internal Controls


A board of directors must ensure that appropriate internal controls are established in order to minimize the risk of inappropriate activities taking place in an organization and to create a system of checks and balances with respect to financial matters. Some examples of internal controls include: (1) establishing policies for financial matters, (2) increased authorization levels for financial transactions above a certain threshold, (3) proper record keeping and retention policies for financial records, (4) protocols relating to access to information, and (5) conducting internal and external audits.[10]


4. Indemnification Agreement


The corporate statutes provide a director with the right to indemnification from the corporation for any costs associated with his defence of any proceedings (civil, criminal, administrative or investigative) brought against him as a result of his association with the corporation. However, the director is only entitled to such indemnification if he acted honestly and in good faith with a view to the best interests of the corporation. Moreover, in a criminal or administrative action, the director must have believed that his actions were lawful.[11]


Notwithstanding the statutory entitlement to indemnification, a director should request that an indemnification agreement be entered into between the corporation and the director. An indemnification agreement would provide a director with additional protection above and beyond the protections available under the corporate statute or the company’s by-laws. The agreement would cover such matters as whether funds would be advanced to the director prior to a final disposition of a proceeding, the quantum of monies available for indemnification, the procedure to request indemnification, and whether the corporation is required to maintain directors’ and officers’ liability insurance.


5. Directors’ and Officers’ Insurance


If a corporation is in a difficult financial position, it may not have the funds available to indemnify its directors. To mitigate against such an event, a potential director should ensure that the corporation has in place directors’ and officers’ liability insurance (“D&O Insurance”). D&O Insurance protects a corporation’s directors and officers against any potential financial loss that they may personally incur in their capacity as directors and officers of the corporation. However, the D&O Insurance coverage would not apply in a situation where a director or officer breached his duties to the corporation and did not act honestly or in good faith.[12]


6. Independent Legal Counsel


As alluded to earlier, there are certain situations in which a director should consult with independent legal counsel – separate from a company’s own legal counsel – in order to determine a suitable course of action.[13] Some of these situations can include: (1) a conflict with and a loss of confidence in the other directors and/or management, (2) pending litigation against the company, (3) a regulatory investigation into the corporation’s affairs, and (4) allegations of gross negligence, fraud or malfeasance.


If a director is in doubt or is uncertain about the proper exercise of his or her duties and responsibilities in a given situation, he or she should consult with a lawyer.[14]


Conclusion


Serving on a company board may prove to be a richly rewarding experience, but before you commit to joining a board, it would be prudent to obtain sufficient knowledge about the business of the corporation and the regulatory and legislative framework within which the company operates. The decision to join a board of directors is one that should be given careful thought and consideration. If you have any questions or concerns about the potential risks and liabilities you may face as a director, it would be prudent to seek the advice of competent legal counsel.


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[1] CBCA, s. 122(1); OBCA, s. 134(1).


[2] CBCA, s. 122(2); OBCA, s. 134(2).


[3] CBCA, ss. 251 and 252; OBCA, s. 258.


[4] CBCA, s. 119; OBCA, s. 131.


[5] CBCA, ss. 25 and 118(1); OBCA, ss. 23 and 130(1).


[6] CBCA, ss. 34, 35, 36, 42, 190 and 241; OBCA, ss. 30, 31, 32, 38, 185 and 248.


[7] CBCA, s.118(2); OBCA, s. 130(2).


[8] Reiter, Barry J. Directors’ Duties in Canada. Toronto, LexisNexis Canada, 2016, p. 1088; CBCA, ss. 123(4) and (5); OBCA, s. 135(4).


[9] Nathan, Hartley R. and Stuchberry, Ira. The Directors’ Handbook. Toronto, LexisNexis Canada, 2019, p. 13.


[10] Reiter, supra note 8 at pp. 1089-1090.


[11] CBCA, s. 124; OBCA, s. 136.


[12] Nathan, supra note 9 at pp. 50-51.


[13] Reiter, supra note 8 at p. 1087.


[14] Nathan, supra note 9 at p. 15.


This article is for informational purposes only and does not constitute legal advice. This article is limited in scope to the duties and liabilities of directors serving on the boards of directors of private companies (i.e., non-public companies) which are governed by the laws of the Province of Ontario or the laws of Canada. The directors’ liabilities discussed in this article are limited to those liabilities which are set out in the Canada Business Corporations Act and the Business Corporations Act (Ontario).


For more information about directors’ duties and liabilities, contact David Kim of Crescendo Law at info@creslaw.com. To learn more about Crescendo Law, visit our website at www.creslaw.com.


Tags: Business Law, Corporate Law, Venture Capital, Private Equity, Start-ups, Scale-ups, Founders, Corporate Governance, Directors’ Duties and Liabilities, Board of Directors


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