People have a business idea. They plan, organize, obtain funding, and decide to incorporate a company to pursue that business idea. When the company is incorporated, it must have at least one director[1]. The person agreeing to act as a director, immediately assumes important responsibilities and duties whether they realize it or not. Understanding what these duties are is important to protect the director from liability and for the proper functioning of the company[2].
Who can be a Director?
Under the Ontario Business Corporations Act all persons except for:
- A person who is less than 18 years of age;
- A person who has been found under the Substitute Decisions Act, 1992 or under the Mental Health Act to be incapable of managing property or who has been found to be incapable by a court in Canada or elsewhere;
- A person who is not an individual[3]; and
- A person who has the status of a bankrupt[4].
may become a director of a corporation. A director is not required to hold shares in the corporation.
What Does it Mean to be a Director of a Corporation?
Directors are the people who manage the company[5]. The directors’ management function (i.e. day to day management) may be delegated to the officers of the corporation[6]. However, even when the management powers are delegated, the directors must continue to oversee the corporation as well as the ongoing business affairs of the company.
Directors owe a fiduciary duty to the corporation. Generally, this means that a director has a duty of loyalty and must act in the best interests of the company. This duty is owed to the corporation and not to the individual shareholder or other stakeholders in the company. On occasion the interests of the corporation and certain shareholders conflict. There are also situations where there may be a conflict between the directors’ own personal interests and those of the corporation. In these situations, the directors’ fiduciary duty continues to be owed to the corporation[7] and supersedes the both the personal interests as well as the shareholders’ interests.
In carrying out their duties, the directors must also exercise the care, diligence, and skill that a reasonably prudent person would exercise in comparable circumstances[8]. This is an objective standard meaning, whether a director believes that their actions were proper is not determinative of the issue. The courts will consider whether the directors’ actions were objectively reasonable and/or prudent. In fulfilling their duty of care, the director must make enough inquiries to inform themselves and consider all material information. These steps and information gathering should be the basis for their ultimate decisions.
Conflicts of Interest.
A director must avoid conflicts of interests with the corporation. There are many potential conflicts of interests which may attract director liability, but we will deal with contract conflicts for the purposes of this brief post[9]. Section 132 of the Ontario Business Corporations Act deals with contracts/transactions between the director and the corporation. In situations where the director is a party to a material contract with the corporation, or has a material interest in a company/person having a contract with the corporation, then the director must disclose the nature of the interest and may not attend in any meeting of directors where the contract is discussed. The director may not vote on the transaction.
Business Judgment Rule.
The business judgment rule protects directors from liability when their decisions were made on an informed, reasonable basis, honestly, prudently and in good faith. This is a significant protection because courts will not view the decisions with the benefit of hindsight. If the decision was made in a reasonable and informed manner, and especially if there were appropriate advisors providing their view on the decision, then a director’s actions should be protected.
Conclusion.
Once a person agrees to act as a
corporate director, there are many obligations that they assume, even
unintentionally. This means that
directors must be diligent in informing themselves of the best way to carry out
this critical function. Liability may
attach to director actions whether or not they are done in good faith, and
whether or not the director subjectively though they were doing the “right”
thing. Learn and then do.
[1] Business Corporations Act, R.S.O. 1990, c. B.16, s. 118 (“OBCA”).
[2] The Corporation should obtain director and officers insurance in order to provide coverage for potential claims.
[3] A company can be deemed to be a person in law.
[4] OBCA, s. 118 (1).
[5] This is subject to a Unanimous Shareholders Agreement (see section 108 of the OBCA). OBCA s. 115.
[6] OBCA s. 133.
[7] A significant amount of litigation centers around whether directors have breached their fiduciary duties. This brief blog post does not outline all the nuances and issues arising from these many scenarios.
[8] OBCA s. 134(1)(b)
[9] As an example, directors may not take or appropriate for himself a corporate opportunity or an opportunity belonging to the corporation.