Protection for Board Directors

When you join a board of directors, and throughout your service on the board, you probably won’t give much thought to the personal financial risk you’ve taken on. And yet, a past board decision could come back to haunt you.

In general, the legal structure of a corporation provides you with protection from personal liability. But that protection is limited. There are instances where directors are held personally liable for a company’s violations of laws or regulations. The possibility of being faced with personal liability – while remote - is something every director needs to take seriously.

The first line of defense against that eventuality is always diligent attention to your duties. But no matter how careful you and your fellow board members are, legal and regulatory issues can still arise. If that happens, board directors can generally count on two lines of defense: indemnification and Directors’ and Officers (D&O) insurance.

In this edition of The Savvy Director, we’ll look at how a director could end up being held personally liable, the importance of due diligence, and a director’s access to indemnification. In an upcoming blog post, we’ll explore the intricacies of D&O insurance.

The Usual Caveat

The purpose of this Savvy Director article is to raise awareness, arouse your curiosity, and provide some general information – not to give legal advice.

The details of directors’ personal liabilities vary by jurisdiction. When it comes to the specifics of directors’ personal liabilities, the details of indemnification, and the complexities of D&O insurance, you and your board should rely on professional advice from experts familiar with your jurisdiction – where the company is incorporated, where it’s active, and the industry it operates in.

The Savvy Director is written from a Canadian perspective, but even within Canada, statutes differ among provinces. Regulations vary by jurisdiction and are often focused on specific industries. As a director, make sure you’re familiar with those that apply and keep up with changes as they occur.

Potential Personal Liabilities

Directors' personal liability refers to the legal responsibility that individual directors may face for their actions or inactions while serving on a board of directors – including for breaches of fiduciary duty, violations of laws and regulations, and other forms of misconduct.

Let’s take a look at some of the actions or non-actions that board directors might be held personally liable for in Canada. (As mentioned above, your own jurisdiction may differ.)

Breach of directors’ duties . If directors fail to fulfill their duty to act in the best interest of the corporation (fiduciary duty) or to exercise reasonable care and diligence in carrying out their duties (duty of care), they can be held personally liable for any damages that result. This can include lawsuits from shareholders, regulatory investigations, and even criminal charges.

Misconduct. Directors may be held personally liable for breaching a contract entered into by the company, for losses or damages resulting from their negligent actions or omissions, and for fraudulent conduct, such as misrepresenting the company's financial statements or hiding material information.

Non-compliance with the governing Business Corporations Act (BCA). Directors have a duty not to support certain types of resolutions that would cause the corporation to fall out of compliance with its governing BCA. Examples include authorizing improper dividends or share issuances for non-monetary consideration. Directors who support such resolutions may be personally liable to repay the improper payments.

Breach of securities laws. Directors of publicly traded companies may be held personally liable if they engage in insider trading, tip off others about material non-public information, unfairly dilute the shares of minority shareholders, or deny shareholders access to information.

Employment law violations. Directors of companies that violate employment standards laws , can be held personally liable for fines, wages, back pay, and other expenses. Directors involved in decisions such as hiring or firing employees may be held personally liable for violations of employment laws such as discrimination or wrongful dismissal. In addition, employers have a duty to ensure their workers’ safety and must comply with all relevant occupational health and safety laws and regulations. Failure to take reasonable care to prevent bodily harm can give rise to fines, penalties and, in some cases, criminal charges.

Environmental breaches. Directors of corporations that violate environmental laws can be held personally liable for damages, particularly if they were aware of the risks and failed to take action to prevent them. Liabilities can include fines, cleanup costs, expenses, and criminal charges.

Unpaid taxes. Directors may be held personally liable for taxes that the company fails to pay or withhold, particularly if they were involved in decisions related to the company's finances.

Canadian Anti-Spam Legislation (CASL). CASL sets rules for commercial electronic messages including emails, text messages, and social media messages. Directors can be held personally liable for regulatory penalties incurred for violations of CASL if they authorized, permitted, or acquiesced to the sending of messages without proper consent, that contain misleading information, or that do not provide an easy way to unsubscribe.

Cybersecurity. There’s a bill before the Canadian parliament right now (Bill C-26) that will make directors within federally regulated industries personally liable for penalties incurred for violations of the new Critical Cyber Systems Protection Act.

Real World Examples

Here are just a few Canadian cases – including publicly traded, private, and non-profit corporations - where directors faced personal liability charges:

• Livent Inc. Directors of this publicly traded company were found liable for misrepresenting the company’s financial statements and were ordered to pay damages.
• nCrowd. A director of this private company was held personally liable for violations of the CASL because commercial electronic messages were sent without consent and unsubscribe mechanisms were non-compliant. An administrative penalty was imposed on the director.
• White Birch Paper. When this private company filed for bankruptcy, several directors were sued by creditors for breaches of their fiduciary duties. The case is ongoing.
• Canadian Olympic Committee. This non-profit was sued by a former employee for wrongful dismissal and directors were sued for breaching their fiduciary duties. The case was settled out of court.
• Mount Sinai Hospital Foundation. This non-profit organization was sued by donors for allegedly misusing funds and directors were sued for breaches of their fiduciary duties. The case was settled out of court.

Start with Due Diligence

When it’s alleged that directors have breached their statutory duties, the defense focuses on due diligence – i.e. that directors made adequate efforts to ensure that the corporation would comply with the law, even if those efforts failed to prevent the non-compliance.

This defense makes it important for directors to ensure that the company fulfills its obligations . As a director, insist on regular reports to the board and ask probing questions to satisfy yourself that there are appropriate policies in place and that, when concerns arise, they are promptly dealt with.

Directors are often required to make difficult decisions based on incomplete or uncertain information. The business judgment rule is a legal principle that affords directors a degree of protection from legal liability if they acted in good faith, with due care, and in the best interests of the company.

For these reasons, proper minutes of every board meeting are a vital protection for directors. Minutes constitute a written record of the board getting information about compliance risks and making careful business judgments in response.

And don’t overlook the importance of careful communication – personal notes and undisciplined comments in emails or texts can be a source of exposure for unwary directors.

Indemnification

Indemnification is a way that companies can limit directors’ personal financial exposure. The company undertakes to reimburse directors, or pay directly on their behalf, the costs of defending themselves and any amounts paid to satisfy an adverse judgment or settle a claim.

The company’s governing documents – the Articles of Incorporation and the bylaws – usually provide for indemnification when it’s legally permitted. In most situations, Canadian statutes permit a corporation to indemnify its directors, but keep in mind that indemnification is expressly prohibited where a director has breached their fiduciary duty. Conversely, where there’s no finding of impropriety, indemnification may be mandatory. To be sure of the details, it’s best to check on the statutes that govern your corporation.

To strengthen directors' indemnification rights, boards may insist on contractual indemnity in the form of an indemnification agreement between the corporation and each of its directors. This kind of agreement provides for up-front payment of legal expenses (instead of reimbursement after the fact) and extends protection for directors after they leave the board. Additional obligations – such as a requirement for D&O insurance – may be included in the agreement.

Questions for the Savvy Director

Here are a few questions to consider raising at your board:

• How can we ensure that directors are aware of their legal duties and potential liabilities?
• What is the company doing to lessen the board's litigation risk?
• How does the company ensure that directors are protected from personal liability?
• How can directors protect themselves from personal liability in their role as board members?
• What policies does the company have to indemnify directors for legal costs and damages arising from their service on the board?
• What are the limitations on the company's ability to indemnify directors?
• What circumstances would trigger the company's obligation to provide indemnification to a director?
• What level of indemnification can a director expect?
• How long is indemnification provided after a director leaves the board?
• How does the company determine whether to provide indemnification to a director?
• What are the potential consequences for a director who is not properly indemnified by the company?

D&O Insurance

D&O insurance is a way of transferring litigation risk from the company and its directors to an insurance company. To learn more about this important and complex topic, stay tuned for our next Savvy Director blog, “D&O Insurance – What You Need to Know”.

Your takeaways:

• No matter how careful you and your fellow board members are, you may find your company embroiled in a situation that could give rise to personal liabilities.
• Directors may face personal liability for their actions or inactions while serving on a board of directors, including breaches of fiduciary duty, misconduct, tax liabilities, and violations of laws and regulations such as employment laws and environmental regulations.
• Situations involving allegations of personal liabilities are not limited to publicly traded companies - private companies and non-profits are also susceptible.
• It’s important that your due diligence is well-documented by the meeting minutes.
• Directors can be indemnified by the company for legal costs and damages through provisions in the corporate bylaws as well as by indemnification agreements.

Resources:

• Before you become a director or an officer of a corporation, read this! Marc Ouimet-McPherson. Droit Ouimet-McPherson Law. November 2023.
• Tips to Protect Nonprofit Board Directors from Personal Liability. Gayle Wadden. Imagine Canada. November 2022.
• New to the Board? Understanding Your Responsibilities Begins with Corporate Law Basics. Stikeman Elliott LLP. October 2018.
• New To the Board? Think About Your Statutory Liability Exposure. Lanette Wilkinson. Stikeman Elliott LLP. October 2018.
• 20 Questions Directors Should Ask About Directors’ and Officers’ Indemnification and Insurance. Richard A. Shaw, QC, ICD.D. ? 2014 CPA Canada.
• Directors and Officers in Canada. ? Stikeman Elliott LLP.
• Due Diligence as a Defence to Directors’ and Officers’ Liabilities. Samantha Horn and Genna Wood. Stikeman Elliott LLP. January 2016.

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Thank you.

Scott

Scott Baldwin is a certified corporate director (ICD.D) and co-founder of DirectorPrep.com – an online membership with practical tools for board directors who choose a growth mindset.