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The Dangers of Driving a Corporation: A Look at Director’s Liability

Director's Liability

When we think about what drives a business, we tend to think about the big picture. We’re familiar with advertising that touts words like ‘ideas’ and ‘innovation,’ and many of us without a corporate background would believe that these are the sort of things that move business forward. Practically speaking though, businesses create value through a series of profit-driven decisions made by their directors for the benefit of the corporations’ shareholders. But what protections do shareholders have against directors who might shirk their management responsibilities and/or act based on their own self-interest?

In small corporations, the roles of the key players often overlap. Small businesses may have owners that are simultaneously directors, officers, and shareholders of the corporation. In these situations, shareholder concerns regarding the management of the company may be more limited. In larger corporations though, directors are often appointed from outside of the business because they can bring a different perspective towards the business’ management. Directors are often appointed and removed by the shareholders based on their track record of making important decisions about the corporation while under pressure.

Serving as a director of a corporation brings a significant responsibility and potential liability. As one can see from below, the law in Ontario outlines the general duties of directors and imposes personal liability on the individual should they not act in the best interests of the corporation.

 A Director’s Responsibility

 There are effectively two sets of rules that govern a director’s responsibilities in Ontario. The first is the law, such as Ontario’s Business Corporations Act (“OBCA”) or the Canada Business Corporations Act (“CBCA”) for corporations that are incorporated federally. These are the laws that set out the bare minimum requirements for corporate directors – they must be a person aged 18 or over, of sound mind, and not bankrupt. A certain number of directors of a corporation must also be residents of Canada (read more about that on our previous blog). The other key set of rules is the shareholders agreement, as it is the shareholders who elect directors in the first place and can use their power to support or dismantle a director’s mandate.

Directors do their job by passing resolutions, which they can do at meetings, or it can be done by way of written resolutions signed by all directors. A Board of Directors will typically have directors serving in important roles to keep the board organized, such as a Chair, one or several Vice-Chairs, and a Secretary responsible for taking minutes of any board meetings. These resolutions have significant power, such as deciding how and when dividends (payments made by the corporation of money earned) can be distributed to shareholders, opening bank accounts for the corporation, and hiring and firing of officers of the corporation. These are important responsibilities, and so directors can be paid a salary by the corporation for their work (whereas dividends are designated for shareholders only).

With their responsibilities, directors of Ontario corporations owe a two-fold duty to the corporation: the first is known as a fiduciary duty and involves the directors’ duty to act honestly and in good faith with regard to the affairs and management of the corporation. The other is a duty of care to act reasonably and prudently in their management of the corporation. These two effectively mean that a director must act responsibly, and in their duties as a director must put the interests of the corporation before their own. They cannot lie or deceive the corporation, or knowingly withhold key information. They must act responsibly and prudently and can face serious consequences for failing to do so.

 A Director’s Liability

The law recognizes and appreciates that most corporate directors are not exclusively corporate directors for a living. Many do not come into the role with an MBA or an accounting degree and have not spent decades analysing balance sheets and corporate strategy. Instead, the law requires that directors act reasonably. They are responsible for showing the same degree of care and due diligence that a reasonable person would show in the circumstances. That does not mean that directors must come into the position all-knowing. Rather directors should make reasonable efforts to satisfy themselves that they have discharged their duties and obligations and may rely on documents such as legal opinions and directors’ reports and seek additional advice where necessary.

The liability associated with being a director may be significant. For example, the OBCA states that directors are “jointly and severally liable to the employees of the corporation for all debts not exceeding six months’ wages that become payable while they are directors for services performed for the corporation” and also for vacation pay earned while the director was with the corporation. Directors can also be held liable for taxes in certain circumstances where the corporation has failed to file properly or may be held liable if the corporation is committing illegal acts while under their watch.

Directors can become parties to other serious proceedings as well. If a corporation goes bankrupt for example or enters into liquidation, the corporation is responsible for paying out amounts such as unpaid wages, vacation pay, termination pay, and potentially severance pay, and directors can be held liable for these amounts if a claim is brought against the corporation within 6 months of their termination. There are other potential liability scenarios as well, and the list is long enough to make any corporate director sit up and take notice.

Thankfully for directors, there is insurance. Corporations can purchase insurance that can protect directors and officers from the personal liabilities that they face in their role, so long as they are acting reasonably in their duties and within the parameters of the insurance policy. Corporations can also compensate (or indemnify) directors for personal liabilities that they face in the course of their duties, again so long as they were acting ethically and honestly.

If all of this sounds complicated, that’s because it certainly can be. Our corporate lawyers regularly advise individuals who are being appointed or are appointed as directors on matters large and small.  We focus on offering practical advice and guidance to directors or prospective directors to ensure they understand their obligations.  We also work closely with corporations, providing them guidance on complex legal issues to help ensure that operations run as smoothly as possible. Contact us today to learn more about how we can help.