Directors’ & Officers’ Liability

Corporate Directors’ & Officers’ Liability

Am I really at personal risk as a director or officer of my corporation?

More to the point, are you willing to lose your personal assets to serve as a corporate director or officer? No matter how heartfelt your belief in the corporation you serve, your answer to the question is likely: “NO!”

Most Canadian corporate Directors & Officers are well aware (or are rapidly becoming aware) of the significant personal risk that service as a director or officer entails. Common Law and many statutes and regulations impose duties and personal liability on corporate directors and officers.

Directors and Officers are expected to balance the interests of an increasingly broad spectrum of “stakeholders” in the corporation, such as shareholders, customers, employees, government agencies, the local community, and others. The Canada Business Corporations Act and numerous Statutes in each Province impose many duties on the company director. (See the attached list of statutes which indicate some of the duties and remedies in law).

You can protect yourself. You can transfer a good part of your risk by the purchase of Directors’ and Officers’ Liability Insurance, popularly know as “D&O”. You can also take a number of measures to minimize your exposure.

So why would the Directors pay, and not the corporation?

Allegations which are most commonly made and which have to be defended by Directors include:

  • Acting beyond the scope of their authority
  • Providing wrong or unprofessional advice
  • Breach of fiduciary duties
  • Authorizing excessive company spending
  • Failure to supervise subordinates or company affairs properly
  • Making unauthorized company borrowing

Remember, the above only need to be alleged for legal and other costs to be incurred in defending the corporate executive. The possibility of these types of charges being made are most likely the result of the following:

  • Acquisitions and divestitures
  • Mergers
  • Foreign investment (especially in the USA)
  • Public offerings
  • Bankruptcy
  • Management buy-outs
  • Reduced dividends
  • Waste or mismanagement of corporate assets
  • Employee dismissal
  • Board room disputes
  • Breach of contract
  • Change in ownership

It is worth remembering that Directors can be held liable for acts committed by other directors simply because they sit on the same board. Also, such damages can extend to the entire personal estate of the director involved.
The corporation may indeed be required to reimburse the directors, because of an “indemnification clause” found in most corporate bylaws. However, in order for that clause to have any effect, the corporation must have sufficient funds put aside to fund the payouts to the directors. In many of the examples above, funds would not be available. Ironically, a sufficient “reserve fund” held in trust for the directors’ indemnification could in itself trigger a shareholder lawsuit for mismanagement of company assets when the economical alternative of purchasing D&O insurance is available.

What about actual claims? Or is this just “sleep insurance”?

Here are a few typical scenarios:

  • A shareholder suit was brought against the Directors of a small company. The complaint alleged that the Directors were negligent in approving and confirming certain share options (as well as deferred compensation plans for the Directors and other key Officers) without first submitting the plans for shareholder approval.
  • All of the Directors of a recently bankrupt privately- owned company discovered that liability is not so “limited” after all. They have been sued by both the Government and employees for withheld tax and back wages respectively.
  • Shareholders of a newly acquired company brought a suit against the Directors & Officers of the parent company charging them with misrepresentation of the tender offer. It was alleged that the tender offer was to the detriment of the selling shareholders of the subsidiary.
  • A government agency brought a suit against the Directors of a non-profit corporation alleging negligence in the handling of donations.

What does the D&O Policy actually do?

The coverage provides personal protection for Directors and Officers of Profit and Non-Profit organizations against liabilities which may be imposed upon them while performing their duties.

Protection is provided against Wrongful Acts, or Alleged Wrongful Acts. A simple definition of a wrongful act would be: “any error, misstatement, act, omission, neglect, or breach of duty committed, attempted, or allegedly committed or attempted, by an insured, individually or otherwise, in their insured capacity.”

The insurance protects individual directors and officers when they are sued individually or jointly. When the operation of an “indemnity clause” in the corporate bylaws causes the corporation to indemnify the directors, the policy will cover the corporation for this instance. Coverage includes damages, judgments, settlements, costs, and defence costs.

There is no “standard form” of coverage. Each insurer has an unique wording, which should be examined for understanding of what is and what is not covered.

There are three areas of general exclusions:

1. Matters too Precarious to Underwrite.

Such as Prior or Pending Litigation. Excluded are matters arising from any litigation, claims, and/or legal or quasi-legal proceedings already in process or known about when the policy coverage begins.

2. Matters covered by other policy types.

Excluded are claims which are more appropriately covered under other policies, such as: Bodily Injury and Property Damage, which would be covered by an Automobile policy or a Commercial General Liability; or Pollution, which can be provided under an Environmental Impairment Policy.

3. Matters Uninsurable under the Law, such as Dishonesty.

Such things as Insider Trading, Remuneration illegally paid to Directors, or any personal profit to which they were not legally entitled, are all examples which are not the subject of liability insurance (which is intended to cover negligence).

Various Statutes affecting Directors’ and Officers’ Liabilities:

  • Ontario Business Corporations Act
  • Canada Business Corporations Act
  • Income Tax Act (Federal)
  • Unemployment Insurance Act (Federal)
  • Canada Pension Plan Act (Federal)
  • Income Tax Act (Ontario)
  • Goods & Services Tax Legislation (Federal)
  • Retail Sales Tax Amendment Act (Ontario)
  • Occupational Health & Safety Act (Ontario)
  • Environmental Protection Act (Ontario)
  • Ontario Water Resources Act
  • Pesticides Act (Ontario)
  • Transportation of Dangerous Goods Act (Federal) and Dangerous Goods Transportation Act (Ontario)
  • Employer Health Tax Act (Ontario)
  • Employment Standards Act (Ontario)
  • Pension Benefits Act (Ontario)
  • Construction Lien Act (Ontario)
  • Canadian Environmental Protection Act (Federal)
  • Fisheries Act (Federal)

The above are just some of the Federal and Provincial pieces of legislation which may impose specific statutory liability upon directors and officers.