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Board Governance Liabilities

"A Canadian Viewpoint"

tdc is providing the following information
as part of our promotional activities.

If governance consultation assistance is required
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In addressing directors' liability, we must ensure that capable men and women are encouraged to serve. Aside from large, well-financed, profitable, well-insured corporations, they should also be motivated to sit on the boards of other entities which need their assistance including corporations in financial difficulty or small entrepreneurial corporations whose success is essential to job creation and the economy of Canada.

The challenge ... is to achieve an appropriate balance. The most able individuals must be encouraged to act as directors, to support reasonable business risk-taking to further the interests of the corporation, and to be diligent in discharging their duties. At the same time, these same individuals should not be exposed to unreasonable potential personal potential risk.

The potential economic costs of directors' liability is a concern.

The Canada Business Corporations Act (CBCA) and the various provincial corporate laws statutes impose statutory liabilities on directors of corporations. In addition, directors can be liable to the corporation for breach of their fiduciary and care duties.

FIDUCIARY DUTY

Both the common law and the Civil Code of Quebec impose fiduciary duties on directors of corporations. One of the principal fiduciary duties of a director is to disclose and/or to avoid conflict of interest situations.

The requirement that directors act honestly and in good faith and in the best interests of the corporation aims to ensure that directors will not place themselves in a position where their duty to act in the best interests of the corporation conflicts with their personal interests.

The fiduciary duty requires a director to be honest in his dealings with the other directors and with the corporation; not only must the director not actively mislead them, but also he or she should not conceal relevant or necessary information from them. Any benefit that a director receives through his fiduciary position belongs to the corporation and he is accountable for it.

DUTY OF CARE

The second aspect of a director's duties is the duty of care. The standard for the duty of care, diligence and skill required of corporate directors is derived from the common law. These are outlined as follows:

(i) a director need not exhibit a greater degree of skill than may reasonably be expected from a person of his +(+) Underlining added. knowledge and experience;

(ii) a director is not liable for errors in business judgment, as his primary function is to use his own particular talents in advocating corporate risk taking; and

(iii) a director is not bound to give continuous attention to the affairs of the corporation. In the absence of grounds for suspicion he is fully justified in trusting corporate officials to be honest. knowledgable and experienced;

DIRECTORS' STATUTORY LIABILITIES

As mentioned earlier, the CBCA and various provincial corporate statutes impose statutory liabilities on directors of corporations. It has been suggested that there are between 100 and 200 statutes in Canada that impose liability on directors. In the environmental area alone, directors can face potential liability under a number of federal and provincial laws.

Among the federal statutes that impose personal liability on directors are the Atomic Energy Control Act, Canadian Environmental Protection Act, Fisheries Act, Canada Business Corporations Act, Bankruptcy and Insolvency Act , Excise Tax Act, Canada Labour Code, Competition Act, Canada Pension Plan, Unemployment Insurance Act, Income Tax Act, Hazardous Products Act, Hazardous Materials Information Review Act and Transportation of Dangerous Goods Act, 1992.

The theory behind directors' civil liability is that the risk of being found liable will make directors more attentive to their legal obligations to manage the corporation.

There are essentially two forms of directors' liability: direct liability and indirect liability. Indirect liability provisions in statutes make directors liable for a corporation's failure to comply with the law.

The direct liability relates to financial obligations where directors face personal liability for a corporation's failure to make certain monetary payments such as wages. Some of these offences impose absolute liability on directors.

DIRECTORS' LIABILITY UNDER THE CBCA

Under the CBCA directors can be liable:

for authorizing the issue of shares for a consideration other than money where the consideration received is less than the fair equivalent of the money the corporation should have received

for certain amounts paid by a corporation, (for example, financial assistance, share redemptions, dividends, or commissions) when the corporation is not solvent ;

for unpaid debts owed to employees such as accrued wages and vacation pay ;

for improper insider trading;

and under the oppression remedy.

DEFENSE MECHANISMS

Good Faith Reliance Defence

The CBCA allows directors to raise a "good faith" defence to many of the liabilities to which they are subject under the Act. Under subsection 123(4), a director is not liable for improper share issuances or payments (s. 118), unpaid wages (s. 119), or breach of fiduciary duty and the duty of care (s. 122) if he or she has relied in good faith upon.

(i) financial statements represented to him or her by an officer or the auditor to reflect fairly the financial condition of the corporation; or

(ii) a report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by him or her.

The Directors' Liability Discussion Paper has this to say about the good faith reliance defence:

The good faith reliance defence is deficient in the limited nature of the circumstances in which it can be used to exonerate a director. The good faith reliance defence allows directors to point to a reliable source of information as justification for their actions, but it does not permit them, in the absence of that specific justification, to show that they acted reasonably under the circumstances.

Due Diligence Defence

It has been suggested that the CBCA's good faith reliance defence be replaced by a due diligence defence for directors. Indeed, the recent report of the Toronto Stock Exchange Committee on Corporate Governance in Canada recommended that legislation which imposes liability on directors should ensure that directors are provided with an effective due diligence defence.

According to the Report:

The existence of a due diligence defence will motivate a board to establish a system within a corporation to ensure that the corporate conduct which is the concern of the relevant law does not occur. The existence of the system is no guarantee that the conduct will not occur but the system should substantially reduce the risk.

The Directors' Liability Discussion Paper describes due diligence in the following manner:

A director will act with due diligence if he/she exercised the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances to prevent the wrongful act. The standard is objective because a director must exercise the reasonable care and skill which an ordinary person might be expected to exercise in the circumstances.

A number of the federal statutes that impose liability on directors also provide for a due diligence defence. The Canadian Environmental Protection Act, which imposes substantial monetary penalties and prison terms for violation of the Act, provides for a due diligence defence in connection with certain offences. Under section 125 of the Act a person will not be found guilty of an offence if it can be established that the person exercised "all due diligence" to prevent its commission. A similar provision is found in the Fisheries Act. A conviction will not be obtained under that statute if the person charged with an offence establishes that he or she exercised "all due diligence" to prevent the commission of the offence, or reasonably and honestly believed in the existence of facts that, if true, would render the person's conduct innocent.

Directors can incur significant liabilities under the Income Tax Act if a corporation fails to deduct or remit taxes withheld from the salaries of its employees. A director will not be liable for these amounts, however, if he or she "exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances"

What constitutes due diligence will depend upon the nature of the statute, the corporation and the situation. Nevertheless, it is possible to state generally that it encompasses:

instituting a system for preventing non-compliance;
training employees in employing the system;
documentation;
monitoring and adjusting the system;
ensuring that adequate authority is given to the appropriate employees;
and planning remedial action in the event of a failure of the system.

Thus, directors should be aware of their own legal obligations as well as those of the corporation, be familiar with the corporation's operations and business affairs and know how the board functions.

Directors should have the tools to carry out their duties; they should establish regular information-reporting systems, ensure that they have confidence in management, and consult expert advisors, where necessary.

Directors should carry out their function diligently and document their activities, exercise independent judgment and communicate their goals and expectations.


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