It is a reality of the late 20th century that directors and officers of companies face numerous potential liabilities. The Companies Act has served to emphasize this reality. Directors and officers, therefore, need to be very concerned about potential liabilities. Prior to the Companies Act, directors already owed fiduciary duties and duties of skill and care to their companies. The Companies Act codifies these duties. It also reinforces and extends these duties in various ways. It is also very significant that the Companies Act increases the range of persons to whom directors are made accountable for breaches of their duties.
The Companies Act describes the overriding fiduciary duty of directors as being to act honestly and in good faith and in the best interests of the company. A breach of this duty usually involves the director doing something that he should not have done at all. The Companies Act also requires a director to exercise the degree of prudence and skill that a normally prudent person would exercise in comparable circumstances. A breach of this duty usually involves the director doing badly something that he may legitimately do.
The Companies Act enforces and supports these general duties owed by directors by a variety of more specific statutory provisions.
For example, directors may be made jointly and severally liable for:
The Companies Act substantially increases the range of persons to whom directors are made accountable. While most directors’ duties are owed to the company itself, the Companies Act provides for a “derivative action” that allows shareholders and others to sue directors on behalf of the company. In some situations, directors are made directly liable to persons other than the company. For example, in relation to insider trading, a director may be liable both to persons who suffer a direct loss and to the company for any benefit received by him. The liability faced by directors where they are found to have been engaged in “oppressive conduct” probably includes liability to shareholders, creditors and others.
Directors always operate under their overriding fiduciary duty to act honestly and in good faith and their duty to exercise skill, diligence and care. However, specific duties and potential liabilities arise in the context of any possible insolvency. In particular, whenever questions arise about the solvency of a company, it is necessary to ensure that the company does not:
As under the former Companies Ordinance, the court can impose personal liability on directors, officers and others for continuing to trade fraudulently or in reckless disregard of whether the company is able to meet its liabilities. The Companies Act also prohibits specified transactions where a company does not satisfy various prescribed solvency tests. Directors who authorise any such transaction are exposed to personal liability.
Directors need to be able to:
Unless the company can pass the relevant solvency test, the Companies Act prohibits certain transactions. These are:
Each of the solvency tests is in two parts. For example, to pass the solvency test prescribed for the payment of a dividend, the company must be able, after the payment of the dividend, to meet its liabilities when they become due; and the realizable value of its assets must exceed the aggregate of its liabilities and stated capital. The first limb of each of the solvency tests is the same. However, the second varies depending upon which of the transactions is being considered.
Directors need information to avoid trading while insolvent and to apply the entire range of solvency tests imposed by the Companies Act. They should:
If a director believes that the company may be, or may become, insolvent he should also:
Even if a director is prima facie liable for breach of one of the duties imposed, there are a number of conditions and limitations imposed on liability which may provide protection in appropriate cases. For example, a director will not be liable for permitting any of the specified transactions (such as financial assistance, share redemptions, dividends or indemnities) when there are grounds for believing that the company is insolvent if he relied in good faith upon:
The Companies Act has also retained a section from the former Companies Ordinance (which does not exist in the Canadian legislation and was not in the Companies Act 1995 until the recent amendments) which provides important protection to directors, officers and auditors. This allows the Court to relieve such persons from liability (wholly or partly) if they have acted honestly and reasonably and, having regard to all the circumstances, ought fairly to be excused.
Provision is made for a company to indemnify directors, and to obtain insurance for them, but only in circumstances where they have acted honestly and in good faith and in the best interests of the company. In specified situations, there are additional requirements for a director or officer to be indemnified, i.e.
Generally speaking, the Companies Act merely allows a company to indemnify a director or officer against personal liabilities but does not require the company to do so. For a director or officer to require an indemnity to be given to him, there must be some positive obligation imposed on the company to provide it.In
In Canada, it is normal for a company’s by-laws to provide that it must indemnify directors and officers if the requirements of the by-laws are met. This practice should usually be followed when continuing an existing company under the Companies Act and when incorporating a new company. A director or officer should never assume the existence of the appropriate By-law but should look into it and ensure that it is as broad as possible. This should be done as part of accepting an appointment and when any important change occurs, such as continuation under the Companies Act. If a director or officer is not satisfied, he should consider resigning. Directors and officers should also take the extra step of getting an express contractual right to an indemnity. This eliminates technical hurdles about enforcing the non-contractual By-laws. It also ensures that the company cannot unilaterally change the right to the indemnity.
A director or officer should never assume the existence of the appropriate By-law but should look into it and ensure that it is as broad as possible. This should be done as part of accepting an appointment and when any important change occurs, such as continuation under the Companies Act. If a director or officer is not satisfied, he should consider resigning. Directors and officers should also take the extra step of getting an express contractual right to an indemnity. This eliminates technical hurdles about enforcing the non-contractual By-laws. It also ensures that the company cannot unilaterally change the right to the indemnity.
There are provisions in the Companies Act which require a company to indemnify directors and officers in specified circumstances, even where there is no By-law or contract to that effect. This right arises under the Companies Act where the director or officer is substantially successful on the merits of the claim and the same “good faith” requirements are met. This provision reflects the fact that if substantial success is achieved, the director or officer should be indemnified.
If a person is nominated by a shareholder to be a director of a company then before accepting such an appointment it would be wise to seek an indemnity from such shareholder who could offer an indemnity in wider terms than that which the company could give and hopefully the nominating shareholder would have a deeper pocket.
Although insurance cover is only available subject to the same “good faith” requirements as apply to indemnities, it is advisable that it be obtained. The reason for this is that an indemnity is of little value if the company that is to provide it has become insolvent. Insurance cover is particularly useful because many instances of director’s liability arise in circumstances where a company is insolvent. It is also important to note that the coverage and exclusions under a policy of insurance must be carefully reviewed, as there may be restrictions in the policy beyond the “good faith” requirements imposed by the Companies Act.