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Board Governance Liabilities
"A Canadian Viewpoint"
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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
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
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.
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
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
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.
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
(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
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
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;
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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