What are Directors’ and Officers’ Duties?

Author: GenNext Chartered Professional Accountants | | Categories: Business Consulting , Business Setup , Business Valuation Services


What are Directors’ and Officers’ Duties?

Under the Canada Business Corporations Act (CBCA) directors and officers have two principal duties: a duty of care and a fiduciary duty of loyalty (to act impartially and place the interests of the corporation first, not allowing their decisions to be tainted by self-interest or self-dealing).

1. Duty of Care  

The duty of care imposed by CBCA requires that "each director and officer of a corporation, in exercising their powers and discharging their duties, must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances". The duty of care requires that directors and officers make sufficient inquiries to inform themselves and consider all material information available to them prior to acting.

Under the duty of care, directors and officers must exercise the same skill, diligence and care that a reasonably prudent person would exercise in similar circumstances. This is an objective standard. It is not sufficient that a director or officer simply does his or her best. Directors are held to the standard of a person with the directors’ skills, training or professional accreditation. For example, an experienced executive serving as a director on a corporation’s board would be held to the same standard that a reasonably prudent experienced executive would exercise in similar circumstances.

If, for example, a director learns of irregularities in the corporation’s finances, the director has a duty to advise immediately the other directors and to ensure the irregularities are properly and promptly investigated. Evidence should be collected and analyzed. An independent investigation by the auditors or other independent experts may be appropriate. To prevent any further financial irregularities, the board should implement and improve controls and oversight.

Though directors owe a duty of care to the corporation, directors should consider the interests of other stakeholders, like creditors, when making major corporate decisions.

There are limitations on a director’s duty of care. A director is not liable for mere errors in business judgement (e.g. commercial decisions made after honest and good faith evaluation). A director is also justified in entrusting certain business decisions to officers of the corporation and in trusting that the officers will perform their duties, unless there are suspicious circumstances.

2. Fiduciary Duty of Loyalty

The CBCA also imposes a fiduciary duty of loyalty that directors and officers act honestly and in good faith with a view to the best interests of the corporation. Under the fiduciary duty of loyalty, directors and officers are to act impartially and place the interests of the corporation first, not allowing their decisions to be tainted by self-interest or self-dealing. The duty requires directors and officers to avoid conflicts between the interests of the corporation and any opposing interests, including their own.

A director should not serve on the boards of corporations which have competing interests. Otherwise, the director could be in a conflict and breach his or her duty of loyalty to the corporations.

2.1 Conflicts of Interests

When a director or officer has a personal interest in a material contract or transaction with the corporation, the CBCA attempts to minimize conflicts of interest between directors and corporations on which boards they serve by requiring directors to disclose such conflicts to the corporation.  He or she must disclose that conflict in writing. If he or she fails to do so, the corporation or its shareholders could apply to a court to request that the contract or transaction be cancelled, and that the director or officer repay any profits or gains he or she realized from the contract or transaction.

Under the CBCA, a director who discloses a conflict of interest must refrain from voting on any resolution to approve the contract or transaction giving rise to such conflict of interest, subject to certain exceptions. Prudence may also dictate, and some provincial statutes require, that such directors MUST not attend any part of a meeting at which such contracts or transactions are discussed.

When conflicts of interest arise, a director must:

  • Declare the nature and extent of the conflict, at the first meeting of directors, at which the relevant contract or transaction is considered;

  • Excuse himself or herself from the meeting where the directors will discuss the issue which led to the conflict;

  • Not vote on the issue which led to the conflict;

  • Not be counted towards the quorum if a meeting is held on the issue which led to the conflict; and

  • Ensure the minutes of the meeting reflect the conflict of interest and indicate that the director excused himself or herself and did not vote on the subject.

All board meetings should begin with a general invitation for directors to declare any conflicts of interest.

If a director discloses his or her interest, does not vote on the related resolution and acted honestly and in good faith at the time a contract or transaction was entered into, he or she will not be liable to the corporation for his or her (personal) gain on the contract or transaction. Also, if two-thirds of votes at a general meeting of shareholders approve of the contract or transaction, the contract or transaction will not be void simply because of the director’s declared conflict.

3. Director Liability  

Because the corporation is regarded as a separate legal entity, directors are generally not personally liable for the contracts, actions or torts of the corporation. Directors and officers are not expected to be perfect or even to be qualified experts. However, corporate and other laws impose some personal liability for directors and officers in specific circumstances.  

The CBCA provides that the corporation may indemnify directors and officers against liabilities incurred in the course of their duties and may purchase and maintain insurance against any liability incurred by the individual in their capacity as a director or officer. If the director or officer has acted honestly and in good faith to the best interests of the corporation, such indemnity is generally available.

Although there is no legal obligation to establish a special committee for Conflict of Interest, except in certain limited circumstances, the creation of a special committee is a way to protect directors from liability by ensuring that a board’s decision-making process is free from the influence of a director who may have a conflicting interest with that of the corporation. Establishing a special committee will protect the board from allegations of wrongdoing and, where the board acts on the recommendation of a special committee, the decision should be respected under the business judgment rule, provided the special committee acted independently and in good faith.

A director may also limit their liability by having their dissent entered into the minutes in respect of a decision or, ultimately, by resigning from the board. The CBCA provides a right to resigning directors to submit to the corporation a written statement giving reasons for resigning, and corporations are in turn required to circulate such statement to shareholders. Resignation will not absolve a director from liabilities incurred while serving as a director.

4. Oppression of Shareholders

Directors must treat all shareholders equally and fairly. If they do not, shareholders can claim they are being oppressed by the directors. If a court determines that a shareholder has been oppressed, the court can award many remedies, including cancelling certain transactions entered into by the corporation, replacing the corporation’s directors or compensating the injured shareholder.  

5. How long does a director's duty of loyalty last?

A director’s or officer’s duty of loyalty does not end when he or she resigns. The duty continues afterwards for a reasonable period. How long this duty survives will depend on the director’s or officer’s importance to the corporation. The more important the director or officer, the longer this duty will last.

A director or officer must wait a reasonable time before starting a competing business, soliciting its customers or employees or benefiting from any opportunity he or she knows of as a director or officer of the corporation.

6. What happens if a breach occurs?

If a director or an officer breaches his or her duty of loyalty or duty of care, then he or she can be liable to the corporation for any loss it suffers that can be directly attributed to his or her actions or omissions. A director should always consider whether his or her decisions or actions are in the best interests of the corporation. For larger boards of directors, committees can be formed to scrutinize reports and approve of decisions to ensure the directors uphold their duty of loyalty and duty of care. The committee should regularly report to the entire board to keep all directors informed.

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