Director’s Risk Management Strategies – Protect Yourself
Directors run the risk of being exposed to significant personal liability for their actions. A risk-management strategy should be developed with 2 broad objectives in mind: it should limit the potential liability of directors and try to shift the remaining risk away from the directors.
Canadian corporate statutes allow a corporation to indemnify its directors, both past and present, where the directors have acted in good faith and in the best interests of the corporation.
However, there are certain limitations. Indemnities will only protect in the case of negligence, and will not cover a breach of a director’s fiduciary duty. In cases where a corporation is suing a director, the corporation may not indemnify the director for costs without the approval of the court. This situation arises in a derivative action where a shareholder or creditor has sued the director on behalf of the corporation. Allowing for an indemnity would mean that the corporation would be reimbursing directors for amounts which directors were required to pay to the corporation.
A corporation is allowed to indemnify a director for fines in criminal or administrative proceedings only if the director had reasonable grounds for believing that the conduct was lawful.
There is mandatory indemnity as prescribed by statute where a director acts honestly, in good faith and in the best interests of the corporation, and is substantially successful on the merits in defending the action. This indemnity applies to past and present directors of the corporation and at the corporation’s request, any person who acts as a director of another entity of which the corporation is a shareholder or creditor.
The corporation shall reimburse all costs relating to litigation in which the director was involved as a result of having been a director. There is no statutory requirement for a corporation to indemnify for any amounts paid to settle an action or satisfy a judgment.
Insurance may provide coverage in situations where an indemnity may not be available, either because indemnification is prohibited by a statute or because the corporation has become insolvent and the directors become liable for amounts such as wages and vacation pay of employees.
A corporation may purchase insurance to protect against any liability incurred by past and present directors and any person who, at the corporation’s request, acts as a director of another entity of which the corporation is a shareholder or a creditor. A corporation may not however, purchase insurance to cover a director’s failure to act honestly and in good faith and in the best interests of the corporation.
Where the director is concerned that the decision was a breach of duty, the board may be able to ratify the decision. It is difficult to apply general rules in these situations. Ratification is not always available and is subject to limitations.
There may be situations when the only way of avoiding liability is to resign from the board. In cases where the corporation is insolvent and cannot meet its obligations to its employees, entire boards have resigned.
Directors should be aware that this only protects them against events after they resign, but does not absolve them of responsibility for any actions taken before their resignations.
We recommend that prior to becoming a corporate director you fully understand your duties and liabilities, including those arising in an insolvency situation. We also recommend you seek independent legal advice as necessary to comply with your duties and you limit your personal liability to the extent possible.
Koby Smutylo – Business Law
236 Metcalfe Street, Ottawa, Ontario K2P 1R3 Canada
Telephone: 613 869 5440 • Facsimile: 613 691 0661 •firstname.lastname@example.org