Behind the corporate veil: Directors’ and Officers’ duties

Directors and officers in Canada operate in a complex business and legal environment. Corporations are required to have a board of directors, and it is customary for them to have at least one officer. These individuals are vital in directly managing the business and affairs of the corporation or overseeing management.

Although Directors and Officers direct the actions of a corporation,  they are generally protected from personal liability by the concept of the “corporate veil.” This concept was established in Salomon v Salomon & Co LTD, where it was held that a corporation is a separate legal personality. This means that, generally, Directors and Officers are not liable for the acts or omissions of a corporation. However, directors and officers may still face personal liability if they fail to carry out their statutory and common-law duties.

This article provides a high-level overview of two overarching duties applicable to directors and officers of Canadian corporations: fiduciary duty and the duty of care. It also briefly touches on risk management strategies corporations can implement to protect their directors and officers from being held personally liable. Although this article focuses on the legal liability of directors, it is important to note that much of the same potential liability may be imposed on officers of a corporation.

Peoples v Wise, the leading case on liabilities of directors, concluded that directors are held to two distinct duties: statutory fiduciary duty and duty of care. These duties are codified in the Canada Business Corporation Act, which states that:

122. (1) Every director and officer of a corporation in exercising their powers and discharging their duties shall:

     (a)   act honestly and in good faith with a view to the best interests of the corporation; and

     (b)  exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable.

 A similar provision can be found in s. 177(1) of Manitoba’s Corporations Act.

Fiduciary Duty             

Directors are characterized as fiduciaries of organizations that they serve, meaning that directors must act honestly and in good faith with a view to the best interests of the organization. In exercising this duty, directors must avoid conflicts of interest, not use their position for personal gain, maintain the confidentiality of the corporation’s information, serve the organization selflessly, honestly and loyally, and exercise independent judgment. Fiduciary duty is owed to the corporation only and is not owed to the various stakeholders. This remains the case even when the corporation is insolvent or near insolvency.  

Specific obligations may arise depending on the circumstances. For example, a director or officer must avoid situations where their obligations to the company and personal interests conflict. This means that one cannot make a profit at the corporation’s expense or compete with the corporation.

To avoid conflicts of interests, a director or officer must disclose all information about agreements they intend to enter or transactions in which they are involved that are potentially relevant to the company.

A director or officer also owes duties of confidentiality, meaning that they must not reveal a corporation’s confidential information. This obligation continues after the director or officer leaves the organization. As long as the information remains the property of the corporation, it must be kept confidential.

While a director and officer may go into a competitive business with the corporation after the end of their term, they cannot use the former corporation’s confidential information or take advantage of their previous position to actively solicit their customers.

Duty of Care

The duty of care is owed by to the corporation and the stakeholders. This second category imposes a duty of care on directors in that they must exercise the care, diligence and skill that a reasonably prudent person in comparable circumstances would exercise.

Generally speaking, a director will not be in breach of his or her duties if they act prudently, diligently and based on their business expertise[BC1] . They are given some deference for decisions they make, which is known as the business judgment rule. Where a director’s decision is a reasonable one in light of all the circumstances about which the director knew or ought to have known, courts will not interfere with that decision.

In the absence of dishonesty, fraud, or self-interest, a court is unlikely to interfere with the decisions of directors, even when it comes to decisions around creditors during a period of insolvency.

An important question that directors and officers may find themselves facing is what happens if the interests of the corporation and various stakeholders are at odds? Whose interests should the director act for? The Supreme Court of Canada answered this question in BCE Inc v 1976 Debenture holders. Where the interests of the corporation and various stakeholders do not coincide the reasonable expectations of the stakeholders can only be that the director acts in the best interest of the corporation.

Risk Management

Even where directors and officers act with reasonable diligence and business expertise, there are circumstances at law that may impose personal liability, especially for directors and officers of insolvent or near insolvent companies. For instance, directors and officers may be liable by statute for various amounts owing by the corporation, including employee source deductions and GST. There are other statutory provisions that may impose personally liability upon directors and officers, and these should be considered before anyone agrees to take on such a role.

While it is not possible for directors and officers to completely avoid the challenges and risks associated with their positions, there are steps that can be taken to mitigate these risks.

The Manitoba Corporations Act permits a corporation to indemnify a director for all costs, charges and expenses, including an amount paid to settle an action or satisfy a judgement reasonably incurred in any civil, criminal or administrative proceeding by reason of being or having been a director, provided that he or she acted honestly and in good faith with a view to the best interests of the corporation (s. 119(1)).

A corporation can also provide each of its directors with a contractual indemnity, which mirrors the indemnification language contained in its corporate bylaws. Each director should have the right to individually defend himself or herself separate from the corporate defence or other director’s defences from any proceedings, at the corporation’s expense. Corporations should also ensure contractual protection extends beyond the term of serving on the board of directors.

The CBCA and the Corporations Act of Manitoba permit a corporation to purchase and maintain director and officer liability insurance. This insurance can cover breaches of fiduciary duties and other sources of personal liability that may be imposed on directors.

It is also important to implement methods to establish due diligence if liability of directors and officers is pursued. Individual directors should keep personal notes of the meetings and request copies of and review the official minutes of each meeting. Meeting minutes should record the individual directors’ votes, and individual directors should keep a copy of all relevant materials and expert opinions.

If you are considering whether to become a director or officer or need legal advice as a current director or officer, contact us. We have a number of lawyers with a wealth of experience acting for directors and officers on a wide range of personal and corporate legal issues.