Can Director’s be Held Personally Liable for a Corporation’s Actions?
The directors of a corporation are elected by the corporation’s shareholders and are required to manage or supervise the management of the business and affairs of the corporation. This power of management can only be restricted, in whole or in part, by an unanimous Shareholder Agreement (USA).
There are two types of obligation imposed on directors in relation to their management of the corporation’s business and its affairs:
- A fiduciary duty to act honestly, in good faith and with a view to the best interest of the corporation; and
- A duty of care and diligence and to act as a reasonably prudent person would in comparable circumstances.
In acting in the best interests of the corporation, directors have a fiduciary responsibility to share knowledge and any business opportunities that may be of benefit to the corporation. As such, the director should not pursue business opportunities for his/her own benefit that belong to the corporation. If a director would like to do business with the corporation that he serves, modern legislation has relaxed the prohibition historically imposed by common law, whereby a director can pursue a business opportunity provided the director discloses his or her interest and abstains from voting in accordance with the applicable legislation.
The duty of care requires directors to take appropriate steps to make informed decisions. Directors must ensure they have the information needed in order to make decisions, assess the information critically and seek input from and test the recommendations of management and the corporation’s advisors.
In order to be a director of a corporation the director must be:
- an individual;
- at least 18 years old;
- of sound mind; and
- not bankrupt.
As of August 1, 2007, at least 25% percent of the directors of every OBCA corporation, other than a “non-resident corporation,” are to be resident Canadians. Where an OBCA corporation has less than four directors, at least one director has to be a Canadian resident.
A Canadian resident is defined in s.1(1) of the OBCA as an individual who is a Canadian citizen ordinarily resident in Canada, a Canadian citizen not ordinarily resident in Canada who is a member of a prescribed class of persons, or a permanent resident within the meaning of the Immigration and Refugee Protection Act and ordinarily resident in Canada.
Transaction of business
Directors act by passing resolutions, which is done either at a meeting of the board of directors or by way of written resolution signed by all of the directors. A resolution passed by the latter method is as valid as if it were passed at a meeting of directors or committee of directors.
Section 137 of OBCA and s.125 of the CBCA authorize the directors to fix the remuneration of the directors, officers, and employees of the corporation. The directors’ discretion in this regard may be limited by provisions in the Articles of Incorporation, by-laws, or a unanimous shareholders agreement, and, of course, by the director’s fiduciary duty and duty of care.
Generally speaking, a director is merely a high-ranking employee of a corporation, whose compensation is by way of salary; whereas dividends (distribution of profit) is reserved for shareholders.
Ceasing to be a Director
Subsection 121(1) of the OBCA and s.108(1) of the CBCA provide that a person ceases to be a director of a corporation if he or she resigns, dies, becomes disqualified, or is removed. A director’s written resignation becomes effective at the time it is received by the corporation if the resignation is to be effective immediately or at the time specified in the resignation, whichever is later.
A director’s resignation cannot be effective prior to the time it is sent to the corporation.
Until the first meeting of shareholders, a first director named in the corporation’s Articles may not resign unless, at the time the resignation is to become effective, a successor is elected or appointed.
Under section 131 of the OBCA, directors of a corporation are jointly and severally liable to the employees of the corporation for all debts not exceeding six month’s wages and up to 12 month’s vacancies pay.
As well, directors may be held personally liable for certain taxes – where the corporation has failed to remit source deductions (employee income taxes, Employment Insurance and Canada Pension Plan contributions), and unpaid employee wages and vacation pay under s.227(1) of the Income Tax Act, or where the corporation has failed to remit HST collected under s.323 of the Excise Tax Act. In these cases include the corporation itself, shareholders, creditors, employees and government agencies.
Directors may also be held personally liable for damages arising as a result of various actions or inaction by the directors, including but not limited to acts that are illegal, which would breach their fiduciary or statutory duties under the act. Additionally, directors may be held personally liable if they permit the corporation to act outside of its authority and for torts committed individually or on behalf of the corporation. Finally, directors can be personally liable where they engage in fraud using the corporation. This is known as piercing the corporate veil.
Directors Liabilities in the Case of Bankruptcy and Liquidation
In cases where the corporation becomes bankrupt or is involved in liquidation, directors are liable to its employees for up to six months of wages, pursuant to the Government of Canada’s Wage Earner Protection Program (WEPP). Under this program, employees may be entitled to a payment for unpaid wages, vacation pay, termination pay and severance pay that the employee earned or became entitled to in the last six months before a bankruptcy or receivership.
When an employee applies for payments from WEPP, he or she agrees to allow the Government of Canada to subrogate their claim, up to the amount of the payment received from the Program. The Government will attempt to recover the amount it has paid under the program from the estate or property of the insolvent employer at the time the assets are distributed through the bankruptcy and receivership process.
But employees must be aware that any claim must be brought within 6 months that payments should have been made or within 6 months of any bankruptcy and liquidation proceedings. If claims are made after that timeline, directors will not be held liable. Moreover, a director’s liability for unpaid wages expires two years after he or she is no longer a director.
Under section 256(2) of the OBCA every person, including the directors of the corporation, who makes or assists in misrepresenting prospectuses or other public company disclosure documents is guilty of an offence. On conviction, he is liable to a fine of not more than $2,000.00 or to imprisonment for a term of not more than one year or to both; if such a person is a body corporate, he is liable to a fine of not more than $25,000.00.
Restrictions on the Use of Corporate Funds
Directors of a corporation are responsible for the distribution of funds to shareholders through the payment of dividends or through share redemption or repurchase. Prior to making any payment to shareholders, directors must ensure that the corporation can meet two financial tests:
- Insolvency Test: When payments are made to shareholders, the corporation must be solvent, meaning that it can meet its financial obligation and liabilities when they are due.
- Capital Impairment Test: This test requires that that prior to any payment being made, the realizable value of a corporation’s assets are at least equal to the sum of its liabilities.
The rationale on these restrictions is that payment should not be made to shareholders where it would be prejudicial to the creditors of the corporation. If payment is made to the shareholders without the director being satisfied, based on a reasonable belief standard, then the director will be personally liable to the creditors for that amount owed.
It is important to note that liability is not limited to legal directors. The law has imported the concept of a ‘de facto director’ into determining liability. A ‘de jure director’ is a director in accordance with the law who has been officially appointed to this position. In contradistinction, a ‘de facto director’ is a director ‘in fact’ which occurs where one acts in the capacity of a director even though they have not been formally appointed to that position. A ‘de facto director’ can be held labile under tax law and other civil statutes.
Indemnification of Directors
Several Canadian corporation statutes provide that a corporation may indemnify the director to the extent of their liability and obtain appropriate insurance to protect directors and former directors against personal liabilities incurred by reasons of them acting as directors. These allowances are subject to the fact that the director has acted reasonably under his/her duty of care and consistently with his or her fiduciary duties and on grounds of his believing that his actions were lawful and in the best interest of the corporation. It is common to put director indemnity provisions in a corporation’s by-laws.
We Can Help
The major theme of directors’s personal duties or obligations is to balance the needs of the corporation with their own interests and to balance the interests of the shareholders against the creditors of the corporation. The liability that ensues for breach of these duties is often in the form of remuneration which often takes the incentive to breach these duties away.
Given the liability associated with acting as a director of a corporation, it is crucial that you hire a qualified and experienced lawyer to help you navigate your rights and responsibilities under corporate law.
Interested to know more about your director’s liability? We’re Here to Help™
-Ghazal Hamedani, Associate Lawyer
Ghazal’s practice is focused on corporate-commercial law, including business formations, corporate reorganizations, shareholder agreements, commercial contracts, the purchase and sale of businesses, as well as secured and unsecured lending transactions. After graduating from University of Toronto with distinction, Ghazal completed her law studies with honours at Cardiff Law in 2017. Ghazal is a lawyer licenced to practice law by the Law Society of Ontario. She is also a member of the Canadian Bar Association and Canadian Corporate Counsel Association Ontario.
© Kalfa Law, 2020
The above provides information of a general nature only. This does not constitute legal advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.