March 1, 2023 | By Craig Zawada, K.C
In our previous article on board unity, we highlighted the need for a board to speak with one voice. We also briefly mentioned another simple, but fundamental, governance principle. Like board unity, this principle is too often misunderstood and misapplied. The difference is that this one involves a statutory obligation with potentially serious consequences.
Here is a common example. You are approached by an old friend who owns the majority of shares in a successful software company. Her business is incorporated under Saskatchewan’s Business Corporations Act, and she has two co-shareholders who work with her in the company. She owns 60% of the shares, and each of her colleagues own 20%. They have agreed, through a unanimous shareholders agreement, that she is entitled to appoint 3 people to the corporation’s board, and each of the other shareholders appoints one.
The business is doing well, and there are no major issues you can see. Your friend says that she wants you on the board because she respects your business acumen and needs someone she can trust “who is watching my back.”
If you have never had governance education, you might think this is perfectly appropriate. She owns a majority of the business, after all. She should have the ability to protect her position. Right?
Because I am talking about this at all, you can probably guess that “right” is not the correct word to use. You must have a good talk with your friend before you accept this offer. To understand why, look at subsection 117(a) of the Business Corporations Act:
117(1) Every director and officer of a corporation in exercising his powers and discharging his duties shall:
(a) act honestly and in good faith with a view to the best interests of the corporation…
The duty is to the corporation. Most of us know that a corporation is a separate legal person. But many glide by what this actually means for board governance. A corporation is not the same as “shareholders.” This is the case even if there is a single shareholder with 100% of the shares. They are not the same.
Case law in Canada has held time and again that a corporation includes numerous stakeholders beyond the owners. Governments, creditors, even the public, will have an interest depending on the circumstances. This may mean their needs and demands can come into play besides only what the shareholders want. Ss. 117(a) codifies that once a person is a director, different considerations arise rather than just pleasing one or more shareholders.
This even applies to shareholders themselves. In a small, closely held corporation, there could be only one shareholder, and they appoint themselves as sole director. They are the same person, obviously, but they wear different hats depending on the circumstances. And if they are acting as a director, ss. 117(a) says they must act in the best interests of the corporation, not themselves (provisions in a unanimous shareholders agreement or specialized Articles can affect this, but we will ignore those for the moment).
Whether one is acting as a shareholder or director seems like a small, maybe insignificant, distinction. Perhaps it is, in most cases. But not every time. You can look to decisions like the Supreme Court of Canada’s in Bell Canada Enterprises Inc. (BCE) v. 1976 Debentureholders, 2008 SCC 69 for confirmation that the corporate interest is the prime directive for directors.
This rule also does not just apply to business corporations (but remember that most business corporation statutes in Canada contain identical provisions). Almost any modern statute governing Canadian non-profits, co-ops, societies and other forms of corporations contains similar language.
The references to Canada and Canadian in the last paragraph are also significant. There is a major difference in the duty in our own back yard – the United States. Directors of American companies, for the most part, owe a duty to shareholders, not the corporation. This has been used, for example, to force a company to pay dividends to shareholders. But as we noted, the duty is different in our country, and the same result might not occur under Canadian law.
It is one thing to know on a logical level that this duty is to the corporation and must be respected. In practice, it sometimes becomes murkier, and is harder to satisfy. One case is the example we used earlier, where the board appointee sits at the behest of a shareholder. It can be hard to separate the desire to please your patron with the legal duty to the corporation.
It also arises in other situations. Suppose the company is a non-profit provincial advocacy group, and its board is entirely elected by members. Perhaps board seats are broken down by geography, so the southwest region of the province elects a director, the northwest gets a director, and so on. It is essential to realize that once a person is elected to the board, their allegiance is no longer to the voters who put them there. It is to the corporation. Many organizations have struggled with directors, or an electorate, which does not understand this. It can be difficult to manage if the director unthinkingly follows the dictates of voters to ensure support in future elections, overlooking potential harm to the corporation.
Another common case where the problem arises is if sectors or groups are granted the right to appoint directors. This often happens when governments provide funding to an organization – they may demand one or more seats on the board. Assuming the corporation was set up under any of the legislation which requires “corporate best interests”, the appointees, and the government, need to realize that the new director(s) will not and cannot simply be mouthpieces for the appointer. In my experience, very few government officials understand this, and the director must educate them from the outset. It is the director who is exposed to liability, after all.
That liability can be significant. It is theoretically possible to attract criminal or quasi-criminal sanctions, although that is admittedly rare. Nonetheless, one big risk is that any activity which raises questions going to the director’s motives can lead to expensive and time consuming legal proceedings. It goes without saying that this should be avoided.
Corporate governance is full of best practices, but also exceptions where situations warrant. When legal liability is involved, however, the options are fewer, and the consequences are higher. Understanding who your duties are owed to as a director is a fundamental first step, and something to always consider during any board activity.
This publication is provided as an information service and may include items reported from other sources. We do not warrant its accuracy. This information is not meant as legal opinion or advice. Contact Procido LLP (www.procido.com) if you require legal advice on the topic discussed in this article.