1 Director and Officer Liability in Insolvent Circumstances by Aaron B. Singer Clark Wilson LLP tel
3 Director and Officer Liability in Insolvent Circumstances 1. Introduction When a corporation is approaching insolvency, it is important that directors and officers of the corporation have a clear understanding of their duties and liabilities to the corporation. A clear understanding will ensure that directors and officers, who are responsible for the affairs of the corporation, can accurately assess their potential for personal liability. Under the common law, directors and officers have always faced potential liabilities for a breach of their duty of care and their fiduciary duty to the corporation. These common law liabilities have been codified in several provincial and federal corporate, environmental, employment and taxation statutes. This paper will address the potential liabilities of directors and officers, examine director and officer liability insurance, and discuss possible ways that directors can limit their potential personal liability during insolvency. 2. Director and Officer Liability (a) Corporate Law Statutes Corporate law statutes place many requirements and duties upon directors and officers that have their origin from the common law. Directors and officers of corporations must adhere to these corporate law duties while not unfairly disregarding, prejudicing or oppressing the interests of stakeholders of the corporation. One of the most basic statutory duties owed by directors and officers is a fiduciary duty to the corporation. This fiduciary duty requires directors and officers to act honestly, in good faith and with a view to the best interests of the corporation. 1 As such, directors and officers must avoid conflicts of interest with the corporation, avoid abusing their position to gain personal benefit and maintain the confidentiality of information they acquire by virtue of their position. A party seeking to prove a breach of a fiduciary duty against a director or officer must show that the director or officer: has scope for the exercise of some power or discretion; can unilaterally exercise this power or discretion so as to affect the party's legal or practical interest; and the party is peculiarly vulnerable to or at the mercy of the director or officer holding the discretion or power. 2 While there is no general rule for determining whether a fiduciary's conduct meets the standard, the following examples from case law may help establish some guidelines: a director 1 Business Corporations Act, S.B.C. 2002, c. 57 [BCBCA], s. 142(a); Business Corporations Act, R.S.C. 1985, c. C- 44 [CBCA], s. 122(1)(a). 2 Lac Minerals v. International Corona Resources Ltd. (1989), 61 D.L.R. (4th) 14 (S.C.C.).
4 p. 2 appointed to represent the interest of a third party such as a shareholder or a creditor has a duty to disclose information to the corporation if it is material to the corporation, even if such disclosure would harm the interests of the party who appointed that director; 3 a director cannot resign from the Board to personally pursue a maturing business opportunity that the corporation itself is actively pursuing; 4 and a director cannot fire all of a corporation's employees, resign from its Board, set up a competing business and actively promote his new business to customers of the old business. 5 Corporate law statutes also require that directors and officers exercise the care, diligence and skill that a reasonably prudent person would in comparable circumstances. 6 This statutory duty of care imposes an obligation on directors and officers to be diligent in supervising and managing the affairs of the corporation. The measure of diligence that must be exercised depends on the circumstances and, at a minimum, includes attending meetings and considering and relying on the advice or opinion of others. Directors are not required to attend every single directors' meeting, but they are required to stay informed about the corporation and its activities. If at a directors' meeting a course of action is approved that is prohibited under statute or the corporation's constating documents, the directors will be jointly and severally liable to the corporation for any loss it suffers. Additional, directors of a corporation are jointly and severally liable if they vote for or consent to a resolution that authorizes: the purchase, redemption or other acquisition of shares if at the time of the proposed purchase or acquisition, the corporation is insolvent, or if the purchase or acquisition would render the corporation insolvent; the payment of an unreasonable commission or discount to a person subscribing for shares if the corporation is authorized to do so by the directors; or the payment of a dividend when the corporation is insolvent or the payment renders the corporation insolvent. 7 Directors who attended or abstained at a meeting at which a prohibited activity was approved may still find be held jointly and severally liable as directors are deemed to have consented to a resolution unless they: enter a dissent in the minutes of the meeting; deliver a written dissent to the secretary of the meeting before its adjournment; or deliver or send by registered mail to the registered office of the corporation a written dissent promptly after the adjournment of the meeting. 8 Directors who are absent from a meeting at which a prohibited resolution activity was approved are deemed to have consented to it unless within seven days after becoming aware of the resolution mails his or her written dissent by registered mail or delivers it to the registered office of the corporation or causes the causes a dissent to be placed with the minutes of the meeting. 9 3 PWA Corp. v. Gemini Group Automated Distribution Systems Inc. (1993), 103 D.L.R. (4th) 609 (Ont. C.A.), leave to appeal refused (1993), 104 D.L.R. (4th) vii (S.C.C.). 4 Roper v. Murdoch (1987), 14 B.C.L.R. (2d) Cantrav West Services Ltd. v. Edwards (1990), 32 C.P.R. (3d) 454 (B.C.S.C.). 6 BCBCA, s. 142(b); CBCA, s. 122(1)(b). 7 BCBCA, s. 154(1); CBCA, s. 118(2). 8 BCBCA, s. 154(5); CBCA, s. 123(1). 9 BCBCA, ss. 154(7) and (8); CBCA, s. 123(3).
5 p. 3 Directors and officers must ensure that they act carefully and deliberately and try to anticipate the probable consequences of a proposed course of action. While directors and officers cannot argue that they should be absolved of the responsibility to take care, it is possible to argue that although care was exercised, the negative consequences of their actions could not have been reasonably anticipated. The Supreme Court of Canada clarified that the standard to which a director will be held is an objective one and does not include any subjective component. 10 The Supreme Court stated that the words "comparable circumstances" do not introduce a subjective element relating to the competence of the director, but rather that the comparable circumstances wording means that the factual aspects of the circumstances surrounding the actions of the director or officer are important considerations. The Supreme Court of Canada also clarified that although directors will be held to an objective standard with respect to care, diligence and skill, courts will nevertheless show deference to decisions of directors and officers acting with due diligence and in the course of exercising their business judgment. This principle of deference to the decision making process presupposes that directors are scrupulous in their deliberations and demonstrate diligence in arriving at decisions. In this regard, while courts are ill-suited and should be reluctant to second guess the application of business expertise to the consideration that are often involved in corporate decision marking, they are capable, on the facts of any case, of determining whether an appropriate degree of prudence and diligence was brought to bear in reaching what is claimed to be a reasonable business decision. 11 According to the business judgment rule, directors are presumed to have acted properly in making a business decision if they acted on an informed basis, in good faith, and in honest belief that the actions taken were in the best interests of the corporation. However, this is only a presumption and it can be disproved. Therefore, directors should investigate all available alternatives in good faith with the skill of a reasonably prudent person; choose options that are the best for the corporation as a whole; ensure that adequate information is available before making decisions at board meetings; attend all board meetings; and take careful notes and document their participation, especially if they dissented to a resolution. 12 Directors are also entitled to rely on the officers of the corporation to perform their duties honestly in the absence of grounds for suspicion. 13 Directors are relieved from liability and have complied with their duties when they rely and act in good faith on: financial statements of the corporation represented to them by an officer of the corporation or in a written report of the auditor of the corporation to reflect the financial condition of the corporation; or a report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made Peoples Store Inc. (Trustee of) v. Wise, 2004 SCC Ibid. 12 D. Huberman et al., British Columbia Corporations Law Guide, looseleaf (North York: CCH Canadian Ltd., 1997) at vol.1, 15, Re City Equitable Fire Insurance Co.,  1 Ch. 407 (C.A.). 14 BCBCA, s. 157(1)(a); CBCA, s. 123(4).
6 p. 4 The Supreme Court of Canada clarified that, even on or after the eve of insolvency, directors do not owe creditors a fiduciary duty. Directors only owe a fiduciary duty to the corporation, not the corporation's stakeholders. Interestingly, however, the court acknowledged that it is legitimate for the directors to consider the interests of shareholders, employees, suppliers, creditors, consumers, governments and the environment but the board must always be attuned to the best interests of the corporation. However, the court added that directors do owe a duty of care that extends beyond the corporation and that duty is owed to creditors. Therefore, where the directors make a decision that is harmful to a creditor, the creditor may be able to sue the directors personally for breach of this duty of care. However, directors will only be held liable if it can be shown that they did not act prudently or on a reasonably informed basis. In other words, business decisions that were reasonable in light of all the circumstances about which the directors knew or ought to have known, though they were not perfect, will not attract personal liability. Directors and officers may have potential personal liability to creditors under the oppression remedy provisions. To be successful in pursuing a claim under the oppression remedy, the claimant must establish that the powers of the directors of the corporation or any of its affiliates are or have been exercised in a manner that is oppressive, unfairly prejudicial to the interests of, or unfairly disregards the interests of certain parties. 15 Because the law in this area is not entirely clear or straightforward, if a corporation is insolvent or nearing insolvency, directors are well advised to seek legal advice regarding their statutory duty of care to creditors and exposure to the oppression remedy. (b) Taxation Law Statutes A corporation has a duty to deduct and remit taxes from employee wages 16, Canada Pension Plan contributions 17, social services tax 18, income tax deductions 19 and goods and services tax 20. If the corporation fails to meet their statutory duties, directors and officers may be held jointly and severally liable, together with the corporation to pay that amount and any related interest or penalties. Directors and officers are held personally liable as the statutes provide that if the corporation commits an offence under the statute, every director and officer who authorized, directed, condoned or participated in the offence is liable to the same penalties as if he or she had committed the offence personally. The timing of a director's resignation can be critical as an individual must be a director at the time the deductions, withholdings or remittances were required to be made in order to be held liable under the Income Tax Act. In addition, the Canada Revenue Agency cannot commence proceedings against a director more than two years after the date the director ceased to be a 15 BCBCA, s. 227; CBCA, s Employment Standards Act, R.S.B.C. 1996, c. 113 [ESA], s. 83(1). 17 Canada Pension Plan Act, R.S. 1985, c. C-8 [CPP], s l 18 Social Services Tax Act, R.S.B.C. 1996, c. 431, ss. 122 & Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) [ITA], s (1). 20 Excise Tax Act, R.S.C. 1985, c. E-15, s. 323(1).
7 p. 5 director. 21 Aside from resignation, directors and officers can avoid personal liability for the corporation's failure to deduct, withhold or remit employee income taxes if the director or officer exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. 22 Directors and officers should be diligent and ensure that the corporation is properly withholding deductions and must make every reasonable effort to ensure that those amounts withheld are remitted and paid. If the corporation is experiencing financial difficulties, it is even more important for directors and officers to exercise due diligence. To demonstrate that they exercised due diligence, directors and officers must show that they took reasonable steps to prevent the failure. To rely on this due diligence defence, directors and officers must show that they took reasonable steps to prevent the failure before it occurred. This defence is fact driven and depends on the circumstances of each case. Courts have held that inside directors who exercise day-to-day management of the corporation's operations and who influence the conduct of the corporations' business affairs will have the greatest difficulty in establishing the due diligence defence. 23 Thus, inside directors are more likely to be found personally liable for a failure to ensure tax remittances were paid. Outside directors may rely on the day-to-day corporate managers to pay debt obligations but are under a positive duty to act once they are in possession of knowledge that remittances are not being made or become aware of facts that would lead to that conclusion. (c) Employment Law Statutes British Columbia corporate law legislation does not contain any provisions regarding personal liability of directors and officer for unpaid wages to employees. If a British Columbia corporation fails to pay the wages of its employees, the directors and officers of the corporation are absolutely liable for up to two months' unpaid wages and commissions. 24 The definition of wages is expansive and includes wages, vacation pay, and severance claims. For federally incorporated companies, directors and officers are liable for all debts of the corporation to employees not exceeding six months wages per employee. 25 The absolute liability of the directors and officers of the corporation means that there are no due diligence defence available. Therefore, anyone who is considered a director or officer at the time wages are not paid to employees is personally liable to account for non-payment of those wages. Consequently, a good course of action would be for directors and officers to have the corporation establish a valid trust fund for unpaid wages, statutory remittances, vacation pay, and employees' pension and employment insurance contributions to ensure that such contributions are paid on time. In an insolvency situation, if the directors and officer establish such a fund far enough in advance of the corporation's insolvency, then they may be successful in retaining the fund to pay obligations for which they might otherwise be personally liable. 21 ITA, s (4). 22 ITA, s (3). 23 Soper v. Canada (1997), 149 D.L.R. (4th) 297 (Fed. C.A.). 24 ESA, s. 96(1). 25 CBCA, s. 119(1).
8 p. 6 Directors and officers of a corporation are not personally liable, however, for any severance pay, termination pay, or money payable in respect of individual or group terminations, if the corporation is in receivership; any liability to an employee for wages, if the corporation is subject to an action under s. 427 of the Bank Act (Canada), or to a proceeding under the Bankruptcy and Insolvency Act (Canada), the Companies' Creditors Arrangement Act (Canada), or the Winding Up Act (Canada); vacation pay that becomes payable after the director or officer ceases to hold office; and money that remains in an employee's time bank after the director or officer ceases to hold office. 26 Therefore, the timing of a declaration of bankruptcy is be critical to limiting the personal liability of directors and officers to their employees as they are not personally liable for any termination or severance payments if the corporation is insolvent or any further employees' wages if the corporation becomes subject to an action under s. 427 of the Bank Act (Canada), or to a proceeding under the Bankruptcy and Insolvency Act (Canada), the Companies' Creditors Arrangement Act (Canada), or the Winding Up Act (Canada). Directors and officers will only be personal liable for vacation pay that become payable while they hold the position of a director. It is also very important to understand that bankruptcy, whether by petition of a creditor or by an assignment by the debtor, has the effect of terminating contracts of employment. This termination triggers the corporation's liability for wages, severance, accrued vacation pay, and other liabilities. The Supreme Court of Canada has held that the termination of employment by bankruptcy can gave rise under provincial employment legislation to a claim by an employee as an unsecured creditor for termination and severance pay. 27 (d) Pension and Employment Insurance Law Statutes Similar provisions imposing liability on directors and officer with respect to employee deductions and remittances are provided for in pension 28 and employment insurance legislation 29, such that directors and officer may be personally liable for the failure of a corporation to deduct and remit employee or the employer contributions. Directors and officers of a corporation that fails to deduct or remit an amount as and when required are jointly and severally liable, together with the corporation, to pay that amount and any interest or penalties assessed on that amount. These statutes both contain both preconditions in terms of unsatisfied judgments by the corporation before the directors and officers will be found personal liable and due diligence defences in terms of acting with the degree of care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances to prevent the act or omission ESA, s. 96(2) 27 Re Rizzo & Rizzo Shoes Ltd.,  1 S.C.R CPP, s. 21(1). 29 Employment Insurance Act, 1996, c. 23 [EIA], s CPP, s. 21.1(2); EIA, s. 46.1(2) and (3).
9 p. 7 (e) Bankruptcy Law Statutes As soon as the corporation enters bankruptcy, all of the corporation's property vests in the trustee in bankruptcy, and the corporation and its directors cease to have any capacity to deal with or dispose of property. 31 Directors may be held personally liable to the corporation's creditors for the wrongful declaration and payment of dividends or the wrongful redemption of shares, even if the corporation did not become bankrupt as a result. 32 If, during the twelve months preceding the bankruptcy, the corporation paid a dividend, other than a stock dividend, or redeemed or purchased for cancellation any of the corporation's shares, at a time when the corporation was insolvent, director may be held jointly and severally liable for the amount of the dividend or the price the corporation paid for the shares. 33 In proceedings against directors personally, the onus is on the directors to prove that the corporation was solvent at the relevant time, or that they had reasonable grounds to believe that the corporation was not on the eve of insolvency. 34 When determining a director's liability, the court must consider whether the director acted as a prudent and diligent person would have acted in the same circumstances, and whether the director relied on any financial statements prepared by the corporation's officers or auditor, or the report of a professional advisor. 35 When a corporation enters bankruptcy, the trustee in bankruptcy generally reviews the transactions made by the corporation within the preceding year to determine if the transactions were made at arm's length and that the corporation received adequate consideration. Directors or officers may be liable if they participated in a transaction where, in the year preceding the bankruptcy, the corporation sold, purchased, leased, hired, supplied or received property or services for a price conspicuously greater or less than the fair market value, as the case may be. 36 There are numerous bankruptcy offences specified in the Bankruptcy and Insolvency Act. 37 If a corporation commits an offence, any director or officer of the corporation or any person who has or had, directly or indirectly, control in fact of the corporation, who directed, authorized, assented to, acquiesced in or participated in the commission of the offence is a party to the offence and liable to conviction whether or not the corporation has been prosecuted or convicted. 38 Anyone convicted of an offence may also be liable to pay compensation to a person for loss or damage resulting from the commission of the offence and this liability is in addition to any other penalties that may be imposed Bankruptcy and Insolvency Act, R.S., 1985, c. B-3 [BIA], s. 71(2). 32 BIA, s BIA, s BIA, s. 101(6). 35 BIA, s. 101(2.1). 36 BIA, s BIA, s. 198(1). 38 BIA, s BIA, s
10 p Director and Officer Liability Insurance A corporation may purchase and maintain insurance for the benefit of its directors and officers against any liability incurred by such individual in the individual's capacity as a director or officer of the corporation, or in the individual's capacity as a director or officer, or similar capacity equivalent to that of a director or officer of the corporation or an associated corporation. 40 In general, the coverage afforded by director and officer liability insurance policies ("D&O Insurance Policies") extend only to reimburse a director or officer for the consequences of honest mistakes. If directors or officers decide to purchase additional coverage at or about the time the corporation files for protection from its creditors, they must remember that like all other insurance policies, there is a strict obligation of good faith on the potential insured to disclose all risks, including the financial situation of the corporation. Directors and officers should carefully review their D&O Insurance Policies and consider the adequacy of the coverage in the context of an insolvency proceeding. In some circumstances, it may be necessary to purchase additional insurance to provide appropriate coverage in insolvency situations. Whenever directors or officers are aware that insolvency is on the horizon, they should have their D&O Insurance Policies reviewed by legal counsel familiar with insolvency issues. (a) Structure of Typical D&O Insurance Policies Unlike many other types of insurance, there is no standard form D&O Insurance Policy. Each insurance corporation underwriting the risk has its own standardized policies and the wording of their policies may change significantly from year to year. As well, many of the provisions of these policies may be negotiated between the insurer and the insured corporation. Typically, however, most D&O Insurance Policies address the following issues: the length of the policy period; names of the insured parties, limits on the insurer's obligations; retentions or deductible amounts; and the premium. While terms of up to three years were once common, most D&O Insurance Policies now have a one year term. Where coverage is not renewed after expiry of the term, the policy may allow an insured to extend the time for reporting claims by the purchase of a discovery period. D&O Insurance Policies typically do not define who is a director or officer of the corporation and reference must therefore be made to the governing corporate legislation. There is, however, often a requirement that the directors must be duly elected and the officers either duly elected or appointed and coverage may be denied for procedural defects in the election or appointment of the director or officer. Most D&O Insurance Policies cover past, present and future directors and officers. Thus, regardless of when the impugned act occurred, a retired or retiring director or officer will be covered by the policy if a claim naming him is made within the policy period. D&O Insurance Policies usually provide that heirs, successors, and representatives of the insured director or officer also receive the benefit of the insuring agreement, as any liability imposed on the director or officer is personal in nature, surviving death. 40 BCBCA, s. 165; CBCA, s. 124(6).
11 p. 9 D&O Insurance Policies also set out the maximum amount for which the insurer is liable to pay for claims made during the policy period, including any extended reporting period. The policies also set out the deductibles, or self-insurance retentions, with respect to each of the corporation reimbursement and the personal liability portions of the policy, with the deductible for the former usually being significantly higher. Some policy wordings will require the corporation to reimburse the director or officer where legally and financially able to do so. This allows the insurer to take advantage of the higher deductible payable by the corporation. (b) D&O Insurance Policy Coverage D&O Insurance Policies are generally written on a claims-made basis and coverage is provided for losses arising out of claims made against insured persons and reported to the insurer during the policy period or any extended reporting period. In order for an insured to be afforded coverage under a D&O Insurance Policy, the following test must be met: the claim must have been made against directors or officers of the corporation; the claim must arise from wrongful acts committed by the officers or directors; and the directors and officers must have experienced a loss. As D&O Insurance Policies are claims-made, coverage will be afforded only for those claims which are first made against the director or officer during the policy period. To be insurable, the claim must relate to the conduct of the directors or officers of the corporation in their capacity as such. As the coverage under the policy does not extend to the wrongful acts of the corporation, a claim made against the corporation alone will not trigger coverage under these policies. As a result, a coverage problem may arise where the insured holds more than one position with the insured corporation. With respect to a claim by the corporation for reimbursement of indemnification sums paid to the officer or director, the insurer will likely be interested in the approval process. This is because the insurer's obligation to pay arises out of the permissive portions of the incorporating statutes with respect to indemnification. Most D&O Insurance Policies specifically exclude punitive or exemplary damages and statutory fines or penalties from the definition of loss. Alternatively, the policy may limit recovery to compensatory damages only. In the absence of such a limitation, an insurer may be required to indemnify for the costs associated with complying with injunctive relief. Under most D&O Insurance Policies, notice of any claims during the policy term must be given by the insured parties to the insurer as soon as practicable. The policy will usually specify the manner in which notice must be given and coverage may be denied if notice is not given in the prescribed manner. (c) Exclusions Most D&O Insurance Policies exclude coverage for intentional acts committed by the insured director or officer including: any personal profit or advantage to which an insured person was not legally entitled; illegal remuneration; active and deliberate dishonesty on the part of the director or officer; wilful violations of law; and profits obtained through violations of securities legislation, particularly insider trading.
12 p. 10 Some of the newer D&O Insurance Policies contain exclusions relating to unintentional acts on the part of the insured. These exclusions generally apply to the policy as a whole and often relate to risks which are, or should be, addressed by other policies: claims addressed or covered by another D&O Insurance Policy; claims arising out of the breach of the fiduciary duties owed by the trustees of employee benefit plans, including pension plans; claims arising out of death, bodily or personal injury, or damage to, or the destruction of, tangible property; claims arising out of an allegation of libel or slander; environmental or pollution claims whether initiated by a government body or private citizens; and claims arising out of a failure to purchase or maintain adequate insurance. The wave of director and officer related litigation in the United States in the 1980s resulted in a number of additional exclusions being added to D&O Insurance Policies: the anti-takeover exclusion excluding any claims arising from a corporate raid; an exclusion for coverage for claims brought by the corporation against the directors and officers, or claims against each other; the regulatory exclusion excludes coverage for claims made by certain regulatory agencies; claims by major shareholders; and mergers, acquisitions and divestitures. (d) Cancellation or Rescission of the D&O Insurance Policy In general, D&O Insurance Policies allow either party to cancel the policy upon notice to the other party. This enables the insurer to cancel D&O Insurance Policies in situations where the risk has increased substantially from that which was originally contemplated. This may leave the policyholders without any insurance coverage when they might need it most, resulting in an action against the insurer by the insured corporation for coverage. Under the Bankruptcy and Insolvency Act, a contracting party may not use the fact of a proposal into bankruptcy of the other party as justification for cancelling a contract. This prevents an insurer from cancelling the D&O Insurance Policy when a corporation files for protection from its creditors. Often the right of the insurer to rescind the D&O Insurance Policy will arise from misrepresentation during completion of the insurance application form. In general, the applicant for D&O insurance coverage is required to provide complete answers as to: the nature of the corporation's business operations, as well as the size of the corporation; previous D&O Insurance Policy history, including prior claims under such a policy and breaks in coverage; current and historical financial information, including current audited financial statements; a description of any litigation involving the corporation or its directors and officers, particularly with respect to actions involving securities, class action, intellectual property; a description of any pending and publicly announced mergers or acquisitions; and a complete description of all pending claims and events or circumstances which may, in the future, give rise to litigation. 4. Limiting Exposure to Liability During Insolvency Many directors consider resigning when their corporation enters a period of financial distress. However, as a general rule, directors cannot avoid personal liability by resigning. Once the financial crisis is at hand, resignation will not eliminate whatever danger of personal liability has already arisen and resignation may damage the director's reputation. In some circumstances, resignation may even increase a director's exposure to personal liability. For example, a director may attract personal liability for leaving the corporation without a sufficient number of directors
13 p. 11 to enable the corporation to act at a critical time. That being said, the importance of delivering a timely and effective resignation cannot be overstated and the decision to resign or to remain should be taken only after careful analysis of all potential consequences. In bankruptcy, the federal or provincial statute of incorporation determines the procedure and effective date of resignation. An individual does not cease to be a director by virtue of the corporation's assignment into bankruptcy. This distinction is important as the effective date of resignation is critically important to directors as it determines the date from which the limitation period for potential claims will run. The following is a non-exhaustive list of things that directors can consider in order to minimize their potential personal liability when a corporation is in the zone of insolvency: - Directors should seek external counsel from both financial and legal advisors as they are aware that the corporation is in financial difficulties. Financial and legal advisors can assist directors and officers in taking into account all of the factors enumerated by the business judgment rule for making informed decisions. The advice that is sought and given should be properly recorded. Directors should then make decisions taking into account the available legal and financial advice and information. - Directors should stay informed and keep up to date with the corporation's latest financial information at all times and be aware of its implications for the corporation. Directors and officers need to devote more time and attention to the corporation's affairs and financial stability in the zone of insolvency than is required when the corporation is financially healthy. - If a director believes that there is no reasonable prospect of the corporation avoiding insolvency then they should immediately bring their opinion to the attention of the board as a matter of urgency. In these circumstances, the corporation should not incur new liabilities unless and until it has been appropriately advised otherwise. - Directors should be fully aware of the fiduciary duties they owe to the corporation and its various stakeholders and ensure that the paper trail reflects acknowledgment of the expanded duties of the corporation and its directors in the zone of insolvency. - Directors should be cautious of giving any form of personal guarantees or allowing the corporation to rely on personal guarantees without taking proper advice as to the implications. - Directors of listed public companies should be familiar with the additional specific duties and obligations derived from the listing rules relating to the market upon which their corporation is listed. - Directors should keep themselves informed, at least in a general way, of the applicable legislation and the different sources of potential liability.
14 p Directors should attentively watch for any potential situation of insolvency. If a director is not convinced that the corporation meets the requirements of the solvency tests, they should make clear that they do not support the proposed transaction or action. - Directors should hold regular board meetings and ensure that the decisions taken and the reasoning behind those decisions are fully documented and recorded. - Directors should not simply resign to avoid the issue of insolvency. If fellow directors disagree with a director's more pessimistic view on the corporation's prospects of continuation as a going concern, resignation may be appropriate. If the director does not resign, any decisions made and the reasoning behind those decisions should be fully recorded. - Directors should choose courses of actions that best serve the entire corporation rather than a single group. Directors should always ensure, in a period of insolvency, that the decisions taken are motivated by good faith, sound business reasons and supported by financial and other data. - Directors should ensure that the assets of the corporation are not dissipated or exploited in a manner unfairly prejudicial to creditors. - If there is no reasonable prospect that the corporation will avoid going into insolvency, directors should take every step with a view to minimising the potential loss to the corporation's creditors as the director ought to have taken. Directors who are concerned about the steps that should be taken in these circumstances to protect themselves from personal liability should also seek specific legal advice in this respect. - Directors should make sure that the corporation's governing documents provide for the corporation to indemnify directors and officers for their official actions; and, make sure that the corporation obtains adequate directors' and officers' liability insurance to back up the indemnification. - Directors should understand and monitor the corporation's solvency to ensure that the corporation meets its financial obligations. If the corporation is encountering significant fluctuations in asset values, it is important to get a good fix on net worth based upon realistic market values, rather than inflated costs. - Directors should carefully consider all major corporate decisions, particularly if those decisions involve a significant risk to the corporation's assets. It is always necessary to act under the business judgment rule, which requires good faith and informed, rational decision making. However, if corporate decisions pose a substantial risk to corporate assets, it might make sense to consult with or obtain the consent of major creditors before implementing such decisions. - Directors should ensure that the corporation has met and continues to meet its ongoing obligation in respect of its remittances of taxes and ensure a reliable system is in place for the corporation to meet the statutory tax remittance obligations. If a director has become
15 p. 13 aware of a failure to deduct, withhold or remit tax amounts, they should act positively and make sure that all reasonable efforts are taken to remedy the problem. - Directors should ensure that the corporation has paid all amounts to employees for wages, salaries, commissions, vacation pay and other compensation owing for services rendered, ensure that there are systems in place to monitor payments owing under employment legislation and ensure that there are mechanisms for alerting directors to any failure of the corporation to maintain its ongoing obligations. - Directors should ensure that the corporation has met and continues to meet its ongoing obligations in respect of deductions and remittances under pension and employment insurance statutes and ensure that there are systems in place to monitor those payments. 5. Conclusion The personal liability of directors and officers in various federal and provincial law statutes are designed to create incentives for directors and officers to take steps to minimize their potential for personal liability. However, even if directors and officers have not been able to take all the steps required to eliminate their potential for personal liability, corporate law statutes allow corporations to purchase D&O Insurance for their directors and officers. These D&O Insurance Policies can help directors and officers to minimize their risk and exposure to personal liability when the policies provide appropriate coverage. Directors and officers should carefully review their policies when the corporation is in the zone of insolvency to ensure that it provides them with the appropriate coverage in their particular situation. Aside from D&O Insurance, directors and officers can protect themselves from much of the personal liability imposed by federal and provincial statutes when they act in a pro-active and diligent manner. By taking steps to ensure that corporate debts, for which personal liability attaches by statute, are paid in a timely manner, directors and officers can often eliminate the debt that is the source of the personal liability before insolvency and provide themselves with a due diligence defence to other potential claims. Directors and officers that exercise the care of a reasonably prudent person, due diligence and reasonable reliance on the advice of legal and financial experts will be able to provide themselves with best defence against the liability imposed in the provisions of many of these statutes. Aaron B. Singer Director and Officer Liability in Insolvent Circumstances T / v1
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