Legal Formality or Competitive Advantage?
Every company needs a board of directors but is it just a legal formality or could good governance also be a competitive advantage in business?
In this guide, we recommend that owners embrace an active board of directors and more broadly good governance as a competitive advantage. We describe the benefits of active directors, how someone qualifies to be a director or officer, the roles of directors and officers, how a director or officer is elected or resigns, the key duties of directors and officers, their potential liabilities and best practices.
By applying these insights, we hope that owners, as well as directors and officers themselves, will build more resilient, more strategic and ultimately more successful businesses.
This is a complicated and evolving area of law. This guide provides a general overview, but it is not exhaustive, and it is not legal advice. For advice on your particular situation, please contact us.
Active Boards help Private Companies Succeed
Directors have an important role within a company. They are elected by the shareholders to manage or supervise the running of the company.
In most private companies, a small group of individuals will fill several different roles. For example, the owner is often elected a director and appointed as President. Joining him or her on the board may be family members, other company executives, shareholders, or company advisors.
In many cases, the same small group of individuals attend to every level of management. The separate roles of shareholders, directors and officers mix, distinctions fade, and the special function of directors can be overlooked.
Meetings of the board of directors may become perfunctory or not be held at all. Often the company minute book may be left on a shelf where it stays until a significant event occurs which requires a resolution of the directors to authorize an action; perhaps the owner wants to declare a dividend or bonus; there’s a tax audit; a shareholder dies or wants to sell his shares; or a lender requires an authorizing resolution for a commitment or obligation.
Benefits of Outside Directors
When private companies overlook the value of a board of directors, they miss an opportunity. An active board can be an invaluable asset especially when it includes individuals from outside the company.
Independent outside directors can serve a useful role by providing owner/operators with impartial and honest advice. Because these directors do not have an agenda to advance or service to sell, they can speak candidly in a way that inside managers or outside professional
advisors may be reluctant to do. They can actively contribute to the future success of a company by providing a wider pool of knowledge, experience and ideas.
Active Outside Directors can:
- Help with the strategic growth of the business;
- Act as a confidential “sounding board” for delicate plans such as choosing a successor;
- Offer new perspectives and encourage creative thinking;
- Monitor the performance of officers and hold them accountable for decisions;
- Take an objective view of disputes;
- Offer advice, guidance and experience to help owners to prepare for future challenges.
Common Objections to an Active Board of Directors
In light of these benefits, why are some business owners reluctant to have independent outside directors? Business owners often raise these concerns:
- Will I lose control?
Directors can be replaced at any time by shareholders. It may be reassuring to add outside directors to the board gradually.
Inside executives or company advisors can still be asked for their opinions – they can contribute to discussions without being directors.
2. Who would risk personal liability of a director?
Some outside directors are concerned about exposing themselves to personal liability. While there are certainly risks, directors of mid-sized private companies normally face much fewer and smaller claims than those of larger public companies.
If potential liability is too intimidating for prospective directors, a company can establish an advisory panel which would advise but not make decisions. The members of the panel would not be exposed to personal liability.
3. Why should I expose myself to criticism?
The purpose of outside directors is not to embarrass or chastise the business owner, but to give constructive guidance, to test assumptions of business plans and to offer a new perspective on important issues.
4. How will I find anyone?
A business owner probably may have more choices than he or she expects. Decide what challenges your business faces and then find a business contact or ask a friend or advisors to suggest someone who has assisted in overcoming similar challenges.
How are directors elected?
A company must have at least one director. A company’s articles of incorporation must specify whether it will have a fixed or a minimum and maximum number of directors. If there is a range, the number of directors can be fixed by a majority vote of the shareholders.
When a company is incorporated, the incorporators also serve as its first directors. At their first meeting, they must either meet and pass or all sign several key resolutions such as approving the by-laws of the corporation, appointing officers, fixing a year end and making banking arrangements.
After the first directors organize the company, at the first meeting of shareholders and at subsequent annual meetings, the voting shareholders elect the company’s directors. If the shareholders do not vote to change the directors, the incumbent directors will continue to hold office until successors are elected or until their term expires. A director’s term may be specified in the corporation’s by-laws, but the term cannot exceed four years. Once a director’s term expires, he or she can be re-elected by the shareholders, unless this is not allowed by the by-laws. The election of directors may be controlled by an agreement among the shareholders.
If a director resigns between annual meetings of shareholders, the other directors can hold a meeting and appoint a replacement. The new director would then hold office until the next annual meeting. If not, enough directors attend a meeting to appoint a replacement, they must call a special shareholders meeting to appoint a replacement.
What sort of indemnity do directors usually receive?
Since directors and officers can be personally liable in certain circumstances, they often ask for an indemnity from the company which has asked them to serve. Usually, there is a general indemnity contained in the company’s general bylaw.
Often this indemnity may not be enough protection. For example, by-laws usually do not require a company to advance funds to help pay a director’s or officer’s legal costs before the claim is settled or decided. This could cause significant financial strain on an officer or a director. To remedy this, the corporation will often agree to pay for a lawyer to help the director or officer defend against a claim.
Any indemnity is limited by the Ontario Business Corporations Act (OBCA) and the Canada Business Corporations Act (CBCA). They state a corporation can only indemnify a director or officer if he or she acted honestly and in good faith with a view to the best interests of the corporation. Also, if a director or an officer is prosecuted for a criminal or an administrative offence or is liable for a monetary penalty, a corporation cannot indemnify that director or officer unless he or she had reasonable grounds for believing that his or her conduct was lawful. Practically, an indemnity depends on the financial strength of the company which gives it. If a corporation becomes insolvent, then its directors will need to look elsewhere for protection.
To buttress an indemnity, directors and officers often ask the corporation they serve to maintain directors’ and officers’ (“D&O”) insurance to cover their potential personal liability. D&O
insurance should reimburse the corporation for any amounts it pays to indemnify its directors or officers. To determine if coverage is appropriate, directors and officers should review the terms of the D&O insurance policy and speak with an expert in insurance.
Who can be a director?
Any individual can be a director so long as he or she is at least 18 years of age, not bankrupt and mentally capable of managing property. Where the corporation is organized under Ontario law or Canadian federal law, at least 25% of its directors must be resident Canadian; or where the company has less than four directors, at least one must be resident Canadian. These requirements also apply to co-operative corporations and not-for-profit corporations under Ontario law and Canadian federal law.
Corporations in some other Canadian provinces are not required to have resident Canadian directors.
What exactly do directors do?
Broadly speaking, directors oversee the business and affairs of the corporation. Directors do not act individually (unless there is only one director). Rather, directors conduct business as a board of directors, by voting on and passing resolutions. Normally, resolutions are voted on at a meeting of directors when a minimum number of directors are present (called quorum). Alternatively, a resolution may be in writing, so long as it is unanimous.
Directors may enact by-laws. By-laws are the internal rules of a corporation that regulate how directors, officers and shareholders can work together. Once a by-law is approved by the directors, that by-law is effective unless it is overruled by the shareholders at the next shareholders meeting.
Directors may also delegate many of their decision-making powers and responsibilities to a managing director, committee of directors or one or more officers.
This ability to delegate powers is useful if, for example, a director has a conflict of interest in a decision to be made by the board. In that case, the board can delegate the decision-making power to a special committee composed of those directors who do not have a conflict.
However, there are certain powers which the directors cannot delegate, including the power to declare dividends; to adopt, amend or repeal a by-law; to submit a question or matter to the shareholders for their approval; and to fill a vacancy of a director, auditor or managing director. These decisions require a resolution by the board of directors (and in some cases the shareholders).
For more discussion about directors meetings and how they are conducted, please see our advisory onConducting a Director or Shareholder/Member Meeting (https://houserhenry.com/wp-content/uploads/2017/02/FAQ-Conducting-a-Director-or-Shareholder-Member-Meeting.pdf).
How are directors compensated?
Unless the corporation’s articles, by-laws or shareholders agreement state otherwise, the directors of a corporation can fix a reasonable level of remuneration for themselves and officers. Also, if a director or officer serves the corporation in another capacity (e.g. as a lawyer or an accountant), he or she can receive reasonable remuneration and expenses for those services.
How can a director resign or be removed?
A director leaves office when he or she dies, resigns, is declared incapable, becomes bankrupt or is removed by a shareholder’s resolution at a meeting of shareholders.
A director can resign at any time. But, prior to resigning, directors should consider the timing. A director is still responsible for liabilities that arose before his or her resignation. During difficult times, directors may want to continue in their role to try to mitigate any potential personal liabilities. If a director resigns, he or she loses influence over the business but is still responsible for the liabilities up to his or her resignation.
When a director resigns, he or she should consider taking steps to avoid leaving the corporation in chaos. This could include giving notice to allow replacement directors to be elected. Directors should also advise the board verbally and in writing of the effective date of his or her resignation. The corporation or the resigning director should also file a notice of resignation with the Ontario or federal government.
A majority of a corporation’s shareholders can vote to remove a director and to appoint his or her successor. If a meeting is called for this purpose, the director may submit a written statement to the corporation and its shareholders that provides reasons opposing his or her removal from the board.
In some cases, a departing director may request a release from the corporation. The prospect of a release will depend on whether the director’s departure was amicable. If the departure was contentious, the director may be asked for a release too but he or she should be careful not to release any indemnities given by the corporation.
Who are the Officers?
Typically, officers manage the day-to-day business and affairs of the corporation. While specific positions may vary from one corporation to another, corporations must have a Secretary and often have a President and a Treasurer. Usually officers are also employees who have a written employment agreement. Employees are not often paid separately for their role as officers.
Directors and officers should be cautious of giving employees senior titles, like Vice-President if these employees are not intended to be officers. Under the “indoor management rule”, if an outsider is dealing with someone who appears to be an officer or a director of a company, that third party can assume the person has the proper authority to enter into a contract on behalf of the company. The third party does not need to investigate the person’s actual authority. To ensure employees with these titles do not misuse their authority, companies can restrict their actual powers in their employment contracts.
How are Officers appointed?
Subject to a unanimous shareholders agreement, the directors appoint officers.
Who is qualified to be an Officer?
Any adult person can be an officer of a corporation; even directors or shareholders. Officers do not need to meet the same requirements as directors. But directors should determine the qualifications they require in an officer.
What do Officers do?
An officer’s powers are also subject to the company’s articles, by-laws, and any unanimous shareholders agreement. The by-laws, and sometimes resolutions of the board, describe broadly the roles of each officer. For example, usually, the President is responsible for the general supervision of the company; the Secretary attends all board and shareholder meetings, records votes and minutes, and gives and receives various notices on behalf of the company; and the Treasurer controls the company’s finances.
What are Directors’ and Officers’ Duties?
Directors and officers have two main duties: a duty of loyalty; and a duty of care.
Duty of Loyalty and Conflicts of Interests
Under the duty of loyalty, directors and officers must act honestly, in good faith, and in the best interests of the corporation. Directors and officers owe this duty to the corporation, and not to its shareholders or creditors. They must not disclose or misuse the corporation’s confidential information. They must make decisions based on the corporation’s best interests.
Directors and officers cannot put personal interests or the interests of other persons or entities ahead of the interests of the corporation. For example, they cannot profit personally from any dealings of the corporation, intercept an economic opportunity of the corporation, or compete with the corporation. Also, they cannot use their position(s) at the corporation to develop or to promote a competing business.
A director should not serve on the boards of corporations which have competing interests. Otherwise, the director could be in a conflict and breach his or her duty of loyalty to the corporations.
When a director or officer has a personal interest in a material contract or transaction with the corporation, he or she must disclose that conflict in writing. If he or she fails to do so, the corporation or its shareholders could apply to a court to request that the contract or transaction be cancelled, and that the director or officer repay any profits or gains he or she realized from the contract or transaction.
When conflicts of interest arise, a director must:
- Declare the nature and extent of the conflict at the first meeting of directors at which the relevant contract or transaction is considered;
- Excuse himself or herself from the meeting where the directors will discuss the issue which led to the conflict;
- Not vote on the issue which led to the conflict;
- Not be counted towards the quorum if a meeting is held on the issue which led to the conflict; and
- Ensure the minutes of the meeting reflect the conflict of interest and indicate that the director excused himself or herself and did not vote on the subject.
All board meetings should begin with a general invitation for directors to declare any conflicts of interest.
If a director discloses his or her interest, does not vote on the related resolution and acted honestly and in good faith at the time a contract or transaction was entered into, he or she will not be liable to the corporation for his or her personal gain on the contract or transaction. Also, if two-thirds of votes at a general meeting of shareholders approve of the contract or transaction, the contract or transaction will not be void simply because of the director’s declared conflict.
How long does a duty of loyalty last?
A director’s or officer’s duty of loyalty does not end when he or she resigns. The duty continues afterwards for a reasonable period. How long this duty survives will depend on the director’s or officer’s importance to the corporation. The more important the director or officer, the longer this duty will last.
A director or officer must wait a reasonable time before starting a competing business, soliciting its customers or employees or benefiting from any opportunity he or she knew of as a director or officer of the corporation.
Duty of Care
Under the duty of care, directors and officers must exercise the same skill, diligence and care that a reasonably prudent person would exercise in similar circumstances. This is an objective standard. It is not sufficient that a director or officer simply does his or her best. Directors are held to the standard of a person with the directors’ skills, training or professional accreditation. For example, an experienced executive serving as a director on a corporation’s board would be held to the same standard that a reasonably prudent experienced executive would exercise in similar circumstances.
If, for example, a director learns of irregularities in the corporation’s finances, the director has a duty to advise immediately the other directors and to ensure the irregularities are properly and promptly investigated. Evidence should be collected and analyzed. An independent investigation by the auditors or other independent experts may be appropriate. To prevent any further financial irregularities, the board should implement and improve controls and oversight.
Though directors owe a duty of care to the corporation, directors should consider the interests of other stakeholders, like creditors, when making major corporate decisions.
There are limitations on a director’s duty of care. A director is not liable for mere errors in business judgement (e.g. commercial decisions made after honest and good faith evaluation). A director is also justified in entrusting certain business decisions to officers of the corporation and in trusting that the officers will perform their duties, unless there are suspicious circumstances.
Directors’ and Officers’ Liabilities
Because the corporation is regarded as a separate legal entity, directors are generally not personally liable for the contracts, actions or torts of the corporation. Directors and officers are not expected to be perfect or even to be qualified experts. However, corporate and other laws impose some personal liability for directors and officers in specific circumstances.
Duty of Loyalty and Duty of Care
If a director or an officer breaches his or her duty of loyalty or duty of care, then he or she can be liable to the corporation for any loss it suffers that can be directly attributed to his or her actions or omissions. A director should always consider whether his or her decisions or actions are in the best interests of the corporation. For larger boards of directors, committees can be formed to scrutinize reports and approve of decisions to ensure the directors uphold their duty of loyalty and duty of care. The committee should regularly report to the entire board to keep all directors informed.
Potential Personal Liabilities
The Ontario Business Corporations Act (OBCA) and the Canada Business Corporations Act (CBCA) state that directors may be liable if they approve the following transactions while the corporation is insolvent, or if it would become insolvent after any of the following:
- Acquires its own shares or warrants (subject to exceptions);
- Repays loans;
- Redeems shares;
- Pays a commission on the purchase of corporation shares;
- Pays a dividend; or
- Pays under an indemnity contrary to the statute.
If such action(s) occur, then those directors who voted for the action(s) will be jointly and severally liable for amounts paid and not otherwise recovered by the corporation.
Directors are also jointly and severally liable to employees of the corporation for up to 6 months of unpaid wages and 12 months of accrued vacation pay, if the corporation cannot satisfy a legal judgment for such amounts (i.e. because the corporation is bankrupt).
Directors can also be personally liable if the corporation does not deduct and remit income tax, employment insurance, or Canada Pension Plan contributions from employees’ salaries, or if the corporation fails to remit Harmonized Sales Tax. However, this potential liability for unremitted taxes can be rebutted with proof of due diligence.
Directors must treat all shareholders equally and fairly. If they do not, shareholders can claim they are being oppressed by the directors. If a court determines that a shareholder has been oppressed, the court can award many remedies, including cancelling certain transactions entered into by the corporation, replacing the corporation’s directors or compensating the injured shareholder.
Playing an Important Role and Avoiding Liability
A director or officer can best protect himself or herself by being well informed about any decisions he or she makes or approves. To be engaged and to mitigate against the risk of personal liability, directors and officers should:
- Review and understand the articles and by-laws of the corporation;
- Define the mission and strategic view of the corporation;
- Ensure that personal indemnification agreements with the corporation are up-to-date;
- Ensure the corporation maintains sufficient insurance for directors and officers;
- Seek legal and accounting advice to understand better applicable laws;
- Insist on written professional opinions from specialists on whose advice the board or management is expected to act;
- Directors should plan for the succession of the Board;
- Ensure that effective management is in place to oversee activities, evaluate the performance of the corporation and confirm that its activities are lawful;
Directors should also:
- Prepare for and attend all meetings by requesting and reading all materials prior to each meeting and taking and keeping detailed notes;
- Review all meeting minutes to ensure the directors’ decision-making process is properly explained, and any disclosures made or any refraining from voting or dissenting is properly documented; and
- Consider his or her duties when making decisions. This includes voting against any payment if there is any question of insolvency or breach of employment law, enquiring about payments which need to be made on your behalf and removing oneself from the decision-making process when a conflict arises.
While officers do not usually meet and vote with the same formality as a board of directors, officers can and should take similar safeguards when performing their duties.
Directors and officers can play a vital
role in the success of a company. To do so, directors and officers need to
understand fully their duties and powers. When directors and officers are well
informed and actively engaged, they can reduce their potential personal
liability and make an enduring contribution to the success of a business.
About Houser Henry & Syron LLP
For over 75 years, Houser Henry & Syron has helped entrepreneurs and private companies of all sizes grow and prosper. We provide a range of business law services – from assisting with day-to-day legal requirements to providing strategic counsel on highly complex transactions. We are uniquely positioned to provide high-quality legal advice, tailored to the specific needs of our clients, at a reasonable price.
This publication provides an
outline of issues for business professionals to consider. The content should
not be taken as legal advice. It is not exhaustive and is subject to change.
Please consult with an HHS lawyer for information or advice specific to your
situation. © HHS 2020
 CBCA, s. 122(1)(b); Peoples Department Stores Inc. (Trustee of) v. Wise,  3 SCR 461, 2004 SCC 68 at para 67 [Peoples].
 Peoples at para 57; BCE Inc. v 1976 Debentureholders,  SCJ No 37, 2008 SCC 69 at para 104.