Duties and Liabilities of Directors and Officers of a Corporation

So, you’re the proud owner/director/president/chief-bottlewasher of a shiny new small business corporation. “President” looks sharp on your business cards. You’re primed to flex your management muscle, and power the company into the marketplace. With that power comes responsibility and risk, however. The laws of Ontario and Canada impose a lot of it on the directors and officers of a corporation. What follows are some of the basic “must-know” duties and liabilities of the people who run companies.

The legal responsibilities of directors and officers of a for-profit corporation come mainly from two laws – the Canada Business Corporations Act (CBCA) and the Business Corporations Act, Ontario (OBCA). They’re similar in most respects, so unless I mention otherwise, you can assume that the same duties and liabilities would apply for a federal or Ontario corporation. These laws have been interpreted and applied by the courts in order to determine what’s expected of those trusted with the operation and direction of a business corporation.

Limited Liability

One of the biggest advantages of a corporation is that it is a separate legal person, which assumes its own liability. If the corporation goes bankrupt, gets sued, or has some sort of accident, the directors and officers of a corporation are generally protected by the “corporate veil.” This means that the corporation is the person that may be held liable, not the people who run it. In exchange for this protection, the law expects directors and officers to fulfill certain duties. In general, more is expected of a director than of an officer. If you don’t live up to those duties, you may lose the protection of the corporate form, and face personal liability.

So What Are these Duties?

1. Management

First things first – directors and officers play different roles in the management of the company. In a startup or small corporation they may be the same people, but as the company grows you’ll need to divide up the responsibilities a little more. Many companies will bring in outside directors with business or other expertise to raise the company’s profile or influence, and guide the business.

The basic role of the board of directors is to manage or to supervise the management of the corporation. Directors are elected by the owners of the corporation – the shareholders – to protect the owners’ interests. Directors’ duties include providing oversight, questioning the reports and recommendations of the officers or committees, and retaining ultimate control and direction over the business of the corporation. Other managerial tasks the directors may do themselves, or delegate them to the officers of the corporation. Delegating duties to officers does not relieve directors of their oversight responsibilities, but absent grounds for suspicion, the directors may trust the officers to perform their duties honestly. Directors should take care not to micromanage the officers by questioning every decision.

Officers – such as the CEO, President, Vice-President, Secretary or Treasurer – are appointed by the board of directors, and are responsible to manage the day-to-day operations of the corporation honestly and in good faith. Officers are usually the “directing minds” of the corporation’s daily business.

2. Fiduciary Duty

Directors and officers are “fiduciaries” of the corporation. Fiduciary is a legal term that means that they owe the utmost loyalty and good faith to the corporation, and must act only in its best interests. They may not put themselves in an actual or potential conflict of interest with the corporation. The courts are very strict in enforcing this duty, and will continue to be so.

The fiduciary duty is designed to protect a corporation against the people who control it using the corporation for their own benefit. The most common breaches of this duty include self-dealing, self-interested actions, and bad faith actions by directors or officers. The duty doesn’t mean that a corporation can’t deal with its directors or officers. Directors and officers must simply take extra steps to ensure that the conflict is disclosed, and the transaction is reasonable and fair to the corporation. The proper procedure to follow in the event of a potential conflict of interest in dealing with a party that director or officer has an interest in will be discussed later.

A director’s fiduciary duty is owed to the corporation, not to the shareholders who nominated them as a director. The limited liability of a corporation will not protect a director who acts in the best interests of their nominator over those of the corporation.

A director can be found personally liable if they use confidential information they received in their capacity as a director or officer to steal business opportunities from the corporation. It is a breach of fiduciary duty, whether it is for their personal gain, or the gain of another entity they have an interest in.

3. Care, Diligence and Skill

Directors and officers must carry out their duties with the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. What is “reasonable” is subjective, and depends on a number of factors, including the:

  • director or officer’s qualifications
  • significance of the action to the director or officer when making the decision
  • time available to make the decision
  • alternatives available to the corporation

Directors and officers are not expected to predict the future, or to make perfect decisions – only to exercise reasonable business judgement. Courts will not intervene in honest, prudent business decisions made in good faith, even if it turns out not to be the best decision after the fact. Directors and officers must be diligent in gathering information, and make business decisions in an impartial and informed manner. This is often a matter of following the proper procedure or process, so long as that process makes sense.

Since the directors have ultimate control over the affairs of the corporation, the board of directors must be able to show that it took an active role in the decision-making process, and document its process and reasons for decisions in minutes of its meetings.

4. Complying with the Law

Directors and officers must comply with their duties under every applicable law, as well as the articles of incorporation and by-laws of the corporation, and must ensure that the corporation does too. Some of the laws that hold directors or officers liable for certain failures to comply are the:

  • Occupational Health and Safety Act (Ontario)
  • Environmental Protection Act (Canada & Ontario)
  • Consumer Packaging and Labeling Act (Canada)
  • Securities Act (Ontario)
  • Criminal Code (Canada)
  • Bankruptcy and Insolvency Act (Canada)
  • Income Tax Act (Canada)
  • Canada Pension Plan Act, Employment Insurance Act, Excise Tax Act (Canada)
  • Ontario Retail Sales Tax Act
  • Consumer Protection Act (Ontario)

5. Conflicts of Interest

As mentioned above, the CBCA and OBCA set out a specific process when a conflict of interest or potential conflict of interest arises for a director or officer.

First, you must disclose the nature and extent of any interest that you have in a material contract or transaction with the corporation, whether it’s already made or simply proposed. An interest in a transaction could be if you’re a director or officer of, or have a material interest in another party to the transaction. Notice is given to the corporation either in a registered letter, or is entered in the minutes of directors’ meetings or meetings of committees of directors.

If you’re required to make such a disclosure, you may not vote on any resolution to approve the contract or transaction, unless it relates to your remuneration, is for indemnity or insurance, or the transaction is with another company that is an affiliate of the corporation.

 So What’s the Risk?

The major liabilities of directors and officers result from failure to fulfill the duties and responsibilities discussed above. Liabilities include:

1. Misuse of Corporate Finances

Directors can be held personally liable to make up the difference if they consent to the issue of shares for consideration other than money (think goods, services, or land) if the corporation doesn’t get a fair value in return. Directors may also be personally liable for unrecovered amounts if they consent to a resolution authorizing:

  • a purchase, redemption or other acquisition of shares
  • a commission
  • payment of a dividend or an indemnity, or
  • payment to a shareholder

…in a manner that’s prohibited by corporate law, the articles of the corporation, or its bylaws.

2. Wages and Employee Payments

This is probably the biggest financial risk of taking on a directorship. In some situations, such as if a corporation is being dissolved, is bankrupt, or lost a wrongful dismissal lawsuit but doesn’t have the money to pay, its directors may be on the hook to make up the shortfall. Directors, who ought to have knowledge of the financial health of the company, can be held personally responsible for up to six months of unpaid employee wages and up to twelve months of vacation pay. This is to protect employees, by deterring directors from putting people to work when the directors know the corporation won’t be able to pay them.

Directors are also personally liable for source deductions such as income tax, EI, and CPP premiums should the corporation fail to remit them.

3. Environmental Contamination

Government officials may issue orders to corporations as well as individually to directors to rectify environmental contamination on the corporation’s land – whether it was caused by the company or not. Failure to comply may result in liability for both the company and its directors.

4. Securities Legislation

For companies that are traded publically on the stock exchange, any person or company that makes a misrepresentation in a filed securities document, commits fraud or insider trading, or manipulates the market may face substantial fines or imprisonment. Any director or officer that knew, or ought reasonably to have known of the illegal act may be personally liable.

5. Civil Liability

Directors and officers may be personally liable in civil court for actions they take that are outside of the scope of their duties – known in law as an “independent, actionable wrong.” So, if someone is suing the corporation, and a director of the company also did something to that person personally, the director may be liable for damages as well. This is common in disputes over firing of employees, oppression of minority shareholders, and sometimes in negligence. When a director is “out to get” somebody, they can’t hide behind the corporation.

A corporation may indemnify its directors and officers – as in, pay the costs of defending them – so long as they acted within their authority, honestly and in good faith, and the lawsuit isn’t the result of their gross negligence or intentionally wrongful act. The corporation may pay the indemnity itself, or take out insurance to cover it. You should speak with the corporation’s insurer, and consider having a clause in officers’ employment contracts stating what is and is not indemnified by the corporation.

 Sounds Like A Lot….

If all of this seems scary, don’t fret. Here are a few simple things that you can do to keep yourself out of hot water:

  • Stay informed about the business of the corporation by:
    • attending all directors’ meetings, or reviewing the minutes if you’re unable to attend;
    • keep your own notes, and review them before attending meetings;
    • reading the terms of the articles of incorporation and the bylaws, and know them to the point where you can verify that the corporation is doing business as it should;
    • knowing what powers have been delegated to officers by the board of directors;
    • reviewing the opinions of professional consultants – including lawyers and accountants;
    • knowing what laws regulate the business or industry, and what liabilities those laws may impose on you;
    • keeping informed about the industry and any environmental or other risks that are associated with it
    • keeping informed of the business activities of the corporation by reading reports from management;
  • If you disagree with the actions of a majority of the board of directors, ensure that:
    • your dissent is recorded in the minutes, or;
    • if you’re not at the meeting but see a resolution in the minutes that you disagree with, ensure your dissent is recorded in a registered letter to the board;
  • Avoid any conflict of interest, particularly in any share transactions that result from inside knowledge of the corporation.
  • If you hold shares of the company, do so as a long-term investment, and minimize trading in order to avoid the appearance of insider trading
  • Ensure that you’re indemnified, and that you know what is covered.

Bear in mind that what’s considered to be “reasonable” in a given situation is highly subjective. When in doubt, call a lawyer. The cost of a legal opinion up-front to clear up a grey area before making a decision is way cheaper than the potential cost of a lawsuit or government fine. I happen to know a guy…

Mike Hook
Intrepid Lawyer
Email: mike@intrepidlaw.ca
Twitter: @MikeHookLaw

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2 thoughts on “Duties and Liabilities of Directors and Officers of a Corporation

  1. Pingback: How do I structure my business? | Small Business Law

  2. Pingback: Legal Aspects of Business Continuation Planning | Small Business Law

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