Directors' liability and the 2001 reform of the  Canada Business Corporations Act: A uniquely Canadian journey1 David G. Masse2 © 2001

[2]  A long time in coming, the proposed changes to the Canada Business Corporations Act (Bill S-11) received Royal Assent in Parliament on June 14th, 2001.  The fairly wide-ranging reform deals with numerous issues that required attention in order to align this key legislation with developments that have occurred in the 26 years since the act was introduced in 1975.  It is currently estimated that the act will be proclaimed in force in October or November 2001, once work in relation to the draft regulations is complete.

[3]  The current reform began in 1994.  Over a period of seven years, Industry Canada carried out extensive consultations in the course of which each key element in the reform was submitted to public discussion and debate.  In the course of those consultations virtually all of the key players having a stake in corporate governance were able to voice their concerns.

[4]  The single issue that elicited the most passionate public response was the question of the scope of directors' and officers' liability.

[5]  The Standing Senate Committee On Banking, Trade and Commerce under the chairmanship of Senator Michael Kirby served as the fulcrum for the reform.  The Committee held extensive public hearings and heard from a large number of witnesses.

[6]  Perhaps the most eloquent statement on the question of directors' liability was uttered by Sir Graham R. Day, a veteran Canadian director:

[7]  "There is no issue today which concerns directors of companies, especially listed companies, more than the threat of their being or becoming personally liable for damages. While, comparatively, Canada overall is less litigious than, for example, the United States, the trends are not reassuring. In theory, directors in Canada face the same exposure to civil liability as their American counterparts. In addition, there is a steadily growing body of Canadian legislation, both federal and provincial, which, in too many instances, can give rise to liability even if a director has exercised "due diligence" in the discharge of his or her duties.
…
[8]  I have been a director of Canadian companies for many years. During that time, I have observed my potential liability increase dramatically.  I acknowledge that this is something which I review and consider regularly. I know there can be no assurance that I can avoid liability arising out of my past service as a director.  However, now I do contemplate, in each separate corporate instance whether continuing to serve, to paraphrase Benjamin Franklin, is "worth the whistle"."³

[10]  The most obvious source of concern in relation to the threat of liability for directors and officers is the proliferation of statutory enactments:

[11]  "It has been suggested to the Committee that there are between 100 and 200 statutes in Canada that impose liability on directors.

[12]  Among the federal statutes that impose  personal liability on directors are the Atomic Energy Control Act, Canadian Environmental Protection Act, Fisheries Act, Canada Business Corporations Act, Bankruptcy and Insolvency Act, Excise Tax Act, Canada Labour Code, Competition Act, Canada Pension Plan, Unemployment Insurance Act, Income Tax Act, Hazardous Products Act, Hazardous Materials Information Act, and Transportation of Dangerous Goods Act."⁴

[14]  Maintaining the balance is, in many ways, more easily said than done.  The law relating to the duties and corresponding liability of directors springs from multiple sources with roots deep in our common law traditions and is a blend of legal, equitable and statutory rules that are intertwined, with one often informing the development of the others over time.  Canadian judges have, from time to time, expressed their frustration when faced with applying the rules to the resolution of often complex conflicts:

[15]  The question of the duty of a director and the considerations which are deemed proper in the execution of that duty have been the subject of myriad decisions. There appears to be no line of authority which clearly delineates the scope of the duty. Indeed, this area of the law seems to be a morass of conflicts and inconsistencies. However, if there is any principle which can be synthesized out of the cases it is that the courts are reluctant to condone, let alone approve, any action which appears unfair, unjust or motivated by self-interest to the detriment of other legitimate interests. This appears especially true when dealing with the power of directors to allot and issue shares from the treasury of the company.⁷

[17]  "Although superficial examination of the legal regime governing Canadian corporations reveals striking similarities to that found in the United States - e.g., corporate statutes containing the standard mix of the broad fiduciary duties of care and loyalty; restrictions on self-dealing transactions; and shareholder voting and initiation rights - there are many important differences in the legal regimes of the two countries that are obscured by focusing solely on the content of corporate statutes."⁸

[19]  In Canada on the other hand, we will see that a fairly coherent body of rules is emerging, largely, though certainly not exclusively, as a result of the influence of Canadian judges.  The jurisprudence of our courts, coupled with the current reform of the sections of the Canada Business Corporations Act dealing with directors' liability, may be the setting for a legal landscape that will live up to the hopes expressed for the new legislation:

[20]  "... the uncertain potential of burdensome potential liability can... create essentially what has been called "liability chill", where a director will limit his or her creativity and risk taking, and, in some cases, even be reluctant to stay on the board of a Canadian corporation...  As a result, this can impede the entrepreneurial strength and the competitiveness of Canadian corporations... To avoid this problem, the bill proposes to bolster the existing "good faith reliance" defence by replacing it with a due diligence defence."¹⁰

[22]  The reform of the Canada Business Corporations Act as it relates to directors' and officers' liability is deceptively simple: it introduces a "due diligence" defence that avails broadly against claims based on the statutory duties imposed on directors and officers under the act.  The most relevant sections of the act, as amended, now read as follows (the substance of the amendment is underlined):

[23]  Duty of care of directors and officers

122. (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; and
(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

Duty to comply

(2) Every director and officer of a corporation shall comply with this Act, the regulations, articles, by-laws and any unanimous shareholder agreement.

No exculpation

(3) Subject to subsection 146(5), no provision in a contract, the articles, the by-laws or a resolution relieves a director or officer from the duty to act in accordance with this Act or the regulations or relieves him from liability for a breach thereof.

123. (1) A director who is present at a meeting of directors or committee of directors is deemed to have consented to any resolution passed or action taken thereat unless

(a) he requests that his dissent be or his dissent is entered in the minutes of the meeting;
(b) he sends his written dissent to the secretary of the meeting before the meeting is adjourned; or
(c) he sends his dissent by registered mail or delivers it to the registered office of the corporation immediately after the meeting is adjourned.

Loss of right to dissent

(2) A director who votes for or consents to a resolution is not entitled to dissent under subsection (1).

Dissent of absent director

(3) A director who was not present at a meeting at which a resolution was passed or action taken is deemed to have consented thereto unless within seven days after he becomes aware of the resolution he

(a) causes his dissent to be placed with the minutes of the meeting; or
(b) sends his dissent by registered mail or delivers it to the registered office of the corporation.

Reliance on statements

(4) A director is not liable under section 118 or 119, and has complied with his or her duties under subsection 122(2), if the director exercised the care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances, including reliance in good faith on

(a) financial statements of the corporation represented to the director by an officer of the corporation or in a written report of the auditor of the corporation fairly to reflect the financial condition of the corporation; or
(b) a report of a person whose profession lends credibility to a statement made by the professional person.

(5) A director has complied with his or her duties under subsection 122(1) if the director relied in good faith on

(a) financial statements of the corporation represented to the director by an officer of the corporation or in a written report of the auditor of the corporation fairly to reflect the financial condition of the corporation; or
(b) a report of a person whose profession lends credibility to a statement made by the professional person.

1974-75-76, c. 33, s. 118; 2001, c. 14, s. 50

[25]  While the reform seems to be a modest response to what is in reality a large and complex problem, it reconciles two important aspects of the law of directors' liability.  At one and the same time it resolves a practical imbalance in the act, and responds to, and bolsters, recent trends in the jurisprudence.

[26]  The synergy between the jurisprudence and the tone set by Parliament in this legislation have enormous potential for further cementing a coherent and unified set of rules for directors' liability with broad application well beyond the confines of the Canada Business Corporations Act.  In order to appreciate the potential impact of the reform it is important to understand the trends in the jurisprudence.

[27]  The due diligence defence

    [28] The duty of care

[29]  The due diligence defence is a direct corrolory of the basic duty of care that directors are bound to exhibit in the performance of their duties.  The duty to manage the affairs of the corporation, as well as the standard of care that directors must bring to that task, is expressed in the Canada Business Corporations Act as follows (an amendment resulting from the reform is underlined¹¹):

[30]  Power to manage

s. 102. (1) Subject to any unanimous shareholder agreement, the directors shall manage, or supervise the management of, the business and affairs of a corporation.

Officers

121. Subject to the articles, the by-laws or any unanimous shareholder agreement,

(a) the directors may designate the offices of the corporation, appoint as officers persons of full capacity, specify their duties and delegate to them powers to manage the business and affairs of the corporation, except powers to do anything referred to in subsection 115(3);

Duty of care of directors and officers

122. (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; and
(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

[32]  "There are, in addition, one or two other general propositions that seem to be warranted by the reported cases: (1.) A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience.  A director of a life insurance company, for instance, does not guarantee that he has the skill of an actuary or of a physician.  In the words of Lindley M.R.: "If directors act within their powers, if they act with such care as is reasonably to be expected from them, having regard to their knowledge and experience, and if they act honestly for the benefit of the company they represent, they discharge both their equitable as well as their legal duty to the company"; see Lagunas Nitrate Co. v. Lagunas Syndicate [1899] 2 Ch. 392, 435."¹⁴

[34]  The precise notion of a "due diligence defence" evolved more or less separately in the realm of public welfare statutes that impose penal consequences for breach of statutory duties.  The seminal case in Canada that served to distill and concretize the due diligence defence is R. v. Sault  Ste-Marie.¹⁶  In that case the municipality had been accused of permitting the discharge of a pollutant contrary to the laws of Ontario.  As the case made its way through the lower courts, it became clear that the law on absolute liability statutory offences was in a state of confusion.  Mr. Justice Dickson, in rendering the judgment of the Supreme Court of Canada, did a thorough review of the jurisprudence and determined that there existed a middle ground between the mens rea required for a conviction of a criminal offence, and simple negligence that would not result in a penal conviction.

[35]  "Where an employer is charged in respect of an act committed by an employee acting in the course of employment, the question will be whether the act took place without the accused's direction or approval, thus negating willful involvement of the accused, and whether the accused exercised all reasonable care by establishing a proper system to prevent commission of the offence and by taking reasonable steps to ensure the effective operation of the system. The availability of the defence to a corporation will depend on whether such due diligence was taken by those who are the directing mind and will of the corporation, whose acts are therefore in law the acts of the corporation itself."¹⁷

[37]  The standard of care required to benefit from the shelter that the due diligence defence affords is essentially the same as that which applies in case of simple negligence, tempered however by a number of considerations that, in practice, mitigate the intensity of the obligation so that it suits the unique features of the corporate environment.

       [38]  An "objective/subjective" standard

[39]  The first tempering aspect of the defence is that it is a flexible test that incorporates subjective elements, allowing the standard to be adapted to meet the particular circumstances in which it is applied.  While the general consensus is that the adoption of the Canada Business Corporations Act in 1975 had the effect of codifying the pre-existing common law relating to the standard of care required of directors while adopting an "upgraded" objective measure of the duty of care,¹⁸ in practice, and on balance, the courts have interpreted the duty in a way that is inconsistent with a purely objective standard.

[40]  One of the leading cases on the due diligence defence as it applies to directors is the 1997 case of Soper v. Canada.¹⁹  The Soper case dealt with the statutory due diligence defence as it exists under the Canadian Income Tax Act.  The wording of the statutory defence in the Income Tax Act is virtually identical to the wording of the director's duty of care under the Canada Business Corporations Act:

[41]  227.1 (3) A director is not liable for a failure under subsection (1) where he exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.  - Income Tax Act S.C. 1980-81-82-83, c.140, s. 124; 1984, c.1, s. 100; 1988, c.55, s. 172

[43]  "30... Thus, in order to determine whether the common law standard of care was modified by statute, it is both appropriate and instructive to consider not only the due diligence provision set out at subsection 227.1(3) of the Income Tax Act but also the analogous, and virtually identical, standard of care provisions found in the Canada Business Corporations Act.

[44]  31. The question of the extent to which the common law standard might have been "upgraded" by these statutes has been questioned by academics and practitioners alike. Some commentators are of the view that, far from effecting a significant modification of the common law standard of care, the relevant legislative provisions established only a slightly more onerous regime than previously existed and one that retains much of its original, subjective character: see e.g. Welling, supra, at page 332. I am in general agreement with that assessment, keeping in mind my earlier comments with respect to director passivity (see discussion supra, at page 146). I begin my analysis by considering each of the statutory standard's constituent elements in turn, namely: skill, care and diligence."²⁰

[46]  "40 This is a convenient place to summarize my findings in respect of subsection 227.1(3) of the Income Tax Act. The standard of care laid down in subsection 227.1(3) of the Act is inherently flexible. Rather than treating directors as a homogeneous group of professionals whose conduct is governed by a single, unchanging standard, that provision embraces a subjective element which takes into account the personal knowledge and background of the director, as well as his or her corporate circumstances in the form of, inter alia, the company's organization, resources, customs and conduct. Thus, for example, more is expected of individuals with superior qualifications (e.g. experienced business-persons).

[47]  41 The standard of care set out in subsection 227.1(3) of the Act is, therefore, not purely objective. Nor is it purely subjective. It is not enough for a director to say he or she did his or her best, for that is an invocation of the purely subjective standard. Equally clear is that honesty is not enough. However, the standard is not a professional one. Nor is it the negligence law standard that governs these cases. Rather, the Act contains both objective elements - embodied in the reasonable person language - and subjective elements - inherent in individual considerations like "skill" and the idea of "comparable circumstances". Accordingly, the standard can be properly described as "objective subjective"."²¹

[50]  The second tempering effect of the law of directors' duties is the concept of reliance.  It is now well established that directors are entitled to delegate their power to manage, as well as to rely on the persons to whom they have delegated to perform their duties with honesty and integrity.  The judgment of the English Court of Appeal in In re National Bank of Wales, Ld.²³ that was endorsed with approval in In re City Equitable Fire Insurance Company Limited, expresses the way in which the reliance on officers extends to the flow of information to the board of directors:

[51]  "was it his duty to test the accuracy or completeness of what he was told by the general manager and the managing director?  This is a question on which opinions may differ, but we are not prepared to say that he failed in his legal duty.  Business cannot be carried on upon principles of distrust.  Men in responsible positions must be trusted by those above them, as well as by those below them, until there is reason to distrust them.  We agree that care and prudence do not involve distrust;  but for a director acting honestly himself to be held legally liable for negligence, in trusting the officers under him not to conceal from him what they ought to report to him, appears to us to be laying too heavy a burden on honest business men."²⁴

[53]  The principle that directors are entitled to rely on management and experts means that in the absence of circumstances that make that reliance unreasonable, directors are not under any duty to enquire, and may rely on the information that they receive from those to whom they have delegated the management of the corporation's business.²⁹

[54]  In order for the reliance to be reasonable, the courts have held that directors must have provided an appropriate framework within which management carries out its responsiblities.  In this respect, the director's duty of care requires that the director take active measures to put in place a system of policies and controls, that, if followed by management, will allow the directors to monitor the activities of the corporation and prevent the breaches of law that would otherwise result in liability.  The establishment of such systems lies at the heart of the due diligence defence.

[55]  The two leading cases on the establishment of such systems are Soper v. Canada³⁰and R. v. Bata Industries³¹.  In the Bata case, the corporation and certain of its senior officers and directors were accused of permitting the discharge of pollutants in contravention of the Ontario Water Resources Act.   After reviewing the duty of care that rested on the shoulders of Bata Industries Ltd.'s directors and officers both under the Canada Business Corporations Act and the Ontario Business Corporations Act and the relevant provisions of the statutes under which the directors were charged, Mr. Justice Ormston concluded:

[56]  "129 Directors of corporations receive further statutory guidance in respect to their responsibilities from the Ontario Business Corporations Act, and the Canada Business Corporations Act.  Under corporate law, directors have the duty to manage or supervise the management of the business and affairs of the corporation "in the best interests of the corporation". They must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. Many of their powers may be delegated to the officers, and they must exercise due care in selecting competent officers.  Directors may be absolved from liability if, as part of managing the business of the corporation, they rely in good faith upon the reports of professionals.
...
[57]  146 I ask myself the following questions in assessing the defence of due diligence:

[58]  (a) Did the board of directors establish a pollution prevention "system" as indicated in R. v. Sault Ste. Marie, i.e., was there supervision or inspection? Was there improvement in business methods? Did he exhort those he controlled or influenced?

[59]  (b) Did each director ensure that the corporate officers have been instructed to set up a system sufficient within the terms and practices of its industry of ensuring compliance with environmental laws, to ensure that the officers report back periodically to the board on the operation of the system, and to ensure that the officers are instructed to report any substantial non-compliance to the board in a timely manner?

[60]  147  I reminded myself that:

[61]  (c) The directors are responsible for reviewing the environmental compliance reports provided by the officers of the corporation, but are justified in placing reasonable reliance on reports provided to them by corporate officers, consultants, counsel or other informed parties.

[62]  (d) The directors should substantiate that the officers are promptly addressing environmental concerns brought to their attention by government agencies or other concerned parties, including shareholders.

[63]  (e) The directors should be aware of the standards of their industry, and other industries which deal with similar environmental pollutants or risks.

[64]  (f) The directors should immediately and personally react when they have noticed the system has failed.

[65]  148 Within this general profile, and dependent upon the nature and structure of the corporate activity, one would hope to find remedial and contingency plans for spills, a system of ongoing environmental audit, training programs, sufficient authority to act and other indices of a proactive environmental policy."³²

[67]  "49 … I turn now specifically to a consideration of outside directors and, in particular, how the standard of care set out in the Act is to be met by them.

[68]  50 In order to satisfy the due diligence requirement laid down in subsection 227.1(3) a director may, as the Department of National Revenue has noted, take "positive action" by setting up controls to account for remittances, by asking for regular reports from the company's financial officers on the ongoing use of such controls, and by obtaining confirmation at regular intervals that withholding and remittance has taken place as required by the Act: see Information Circular, No. 89-2, supra, at paragraph 7.

[69]  51 Likewise, some commentators have advised directors that, if they wish to be able to rely successfully on the due diligence defence, it would be wise for them to consider undertaking a number of "positive steps" including, in certain circumstances, the establishment and monitoring of a trust account from which both employee wages and remittances owing to Her Majesty would be paid: see e.g. Moskowitz, supra, at pages 566-568."³³

[71]  "The Board saw no red flags from the auditors or from Central, and there were indeed no red flags from them. But there were many red flags from Scullion and McGonegal, outlined above, that were ignored or passed over by the directors and the Board. It is true that there can be no fraud without trust, and it is true that the Board and the directors are entitled to place trust and faith in bheir servants when there is no reason to doubt them.

[72]  But trust does not mean blind trust. Even though there was no direct evidence of fraud before the Board, there were mainy questions they should have asked. There were many questions they did ask, but they neglected to ensure that their questions were answered. The most simple inquiries would have led to the discovery of the scam."³⁴

[75]  The director's duty of reasonable diligence or care is distinguished by another rather unique feature that further tempers the intensity of the director's duty.  A firm principle has evolved that courts will be reluctant to interfere with the business decisions that directors make.  This principle is often refered to as the "business judgment rule".  This is as appropriate as any other term to describe this principle, but, on balance, is a rather unfortunate choice as it invites comparisons with a similar principle that has evolved in the United States but which, when applied, is not likely to lead to similar results.³⁵  While some authors refer to the "business judgment rule" as applicable in Canada in much the same way as it is applied in the United States,³⁶  the better view is that the Canadian principle is distinct,³⁷ and operates in close conjunction with the director's general duty of diligence and care:

[76]  "Canadian courts have not articulated a specific "business judgment rule" and may not always give it as much weight as courts do in the United States.  Nonetheless there is a general reluctance to find a director failing in the duty of care simply because a business decision turns out to be the wrong one, even possibly a foolish one. The implicit or explicit application of the business judgment rule results in the focusing of judicial attention on the process of decision-making rather than on the result. If the board of directors acquires the necessary information, asks questions, and puts its mind to the issue, the courts are likely to find that the duty of care has been fulfilled, whether or not the ultimate decision is sound from a business point of view."³⁸

[78]  "In assessing whether or not directors have met their fiduciary and statutory obligations, as outlined earlier in these reasons, Canadian courts have generally approached the subject on the basis of what has become known as the "business judgment rule". This rule is an extension of the fundamental principle that the business and affairs of a corporation are managed by or under the direction of its board of directors. It operates to shield from court intervention business decisions which have been made honestly, prudently, in good faith and on reasonable grounds. In such cases, the board's decisions will not be subject to microscopic examination and the court will be reluctant to interfere and to usurp the board of director's function in managing the corporation."⁴⁰

[80]  "There can be no doubt that on an application under s. 234 the trial judge is required to consider the nature of the impugned acts and the method in which they were carried out. That does not mean that the trial judge should substitute his own business judgment for that of managers, directors, or a committee such as the one involved in assessing this transaction. Indeed, it would generally be impossible for him to do so, regardless of the amount of evidence before him. He is dealing with the matter at a different time and place; it is unlikely that he will have the background knowledge and expertise of the individuals involved; he could have little or no knowledge of the background and skills of the persons who would be carrying out any proposed plan; and it is unlikely that he would have any knowledge of the specialized market in which the corporation operated. In short, he does not know enough to make the business decision required. That does not mean that he is not well equipped to make an objective assessment of the very factors which s. 234 requires him to assess. Those factors have been discussed in some detail earlier in these reasons.

[81]  It is important to note that the learned trial judge did not say that business decisions honestly made should not be subjected to examination. What he said was that they should not be subjected to microscopic examination."⁴¹

[83]  In addition to the general duty of care, directors have fiduciary duties that stem from the rules of equity.  The essence of the director's fiduciary duty may be succinctly stated in the way that it is codified in the Canada Business Corporations Act:

[84]  122. (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; and

[86]  In such situations, the court will scrutinize the behaviour of directors to ensure that their actions are taken with a view to furthering the best interests of the corporation that they serve.  Here too we find that there are currents in the jurisprudence that have proven difficult to reconcile in the past.  For example, one vein of tension has been the way the courts in Canada have dealt with a principle known as the "proper purpose doctrine".  It was the difficulty of dealing with the conflicting case law on that subject that prompted the remarks of Mr. Justice Richard in the case of Exco Corp. Ltd. v. Nova Scotia Savings & Loan Co.⁴² referred to earlier at paragraph 15.

[87]  Yet even in this difficult area, there is some evidence of a common thread that relates the director's duty of care in the context of his or her fiduciary duties back to the fundamental requirement of diligence and care.  A recent case that demonstrates the intertwining of the duty of care and the ficudiary duty is the judgment of the Ontario Court of Appeal in Maple Leaf Foods v. Schneider Corporation et al.  In that case Mr. Justice Weiler in rendering the court's judgment wrote:

[88]  "One way of determining whether the directors acted in the best interests of the company, according to Farley J., is to ask what was uppermost in the directors' minds after "a reasonable analysis of the situation.": 820099 Ontario Inc. v. Harold E. Ballard Ltd. (1991), 3 B.L.R. (2d) 123 at p. 176 (Ont. Gen. Div.), affirmed (1991), 3 B.L.R. (2d) 113 (Ont. Div. Ct.); CW Shareholdings Inc. v. WIC Western International Communications Ltd., No. 98-CL-2821 (May 17, 1998), Toronto (Gen. Div.) reported 39 O.R. (3d) 755, 160 D.L.R. (4th) 131. It must be recognized that the directors are not the agents of the shareholders. The directors have absolute power to manage the affairs of the company even if their decisions contravene the express wishes of the majority shareholder: Teck Corp. Ltd. v. Millar, supra, at p. 307. However, acting in the best interests of the company does not necessarily mean that the directors must act in the best interests of one of the groups protected under s. 234. There may be a conflict between the interests of individual groups of shareholders and the best interests of the company: Brant Investments Ltd. v. Keep Rite Inc. (1987), 60 O.R. (2d) 737, 42 D.L.R. (4th) 15 (H.C.J.), affined (1991), 3 O.R. (3d) 289 at p. 301, 3 O.R. (3d) 289 (C.A.). Provided that the directors have acted honestly and reasonably, the court ought not to substitute its own business judgment for that of the Board of Directors: Brant Investments v. KeepRite Inc."⁴³

[90]  The oppression remedy that was introduced in sections 241 and following of the Canada Business Corporations Act in 1975 provides the court with broad powers to redress the actions of the corporation or its directors that oppress or unfairly disregard the interests of shareholders, creditors, directors or officers.  The sweeping powers that the act places in the hands of the judiciary might easily have increased the risk exposure of directors.  In reality Canadian courts have exhibited restraint and have generally exercised their jurisdiction in matters of oppression in a manner that is consistent with the law relating to the general duties of directors.

[91]  Thus, Canadian courts have continued to apply the same fundamental rules that they apply when assessing the director's duty of diligence and care or the director's fiduciary duty.  In this way the court considers the director's conduct in accordance with the standard of care, as tempered by the subjective elements in the duty of care, the principle of reasonable reliance, and the principle of deference to the director's business judgment.  A good example of that approach is illustrated in the case of CW Shareholdings Inc. v. WIC Western International Communications Ltd. :

[92]  "In assessing whether or not directors have met their fiduciary and statutory obligations, as outlined earlier in these reasons, Canadian courts have generally approached the subject on the basis of what has become known as the "business judgment rule". This rule is an extension of the fundamental principle that the business and affairs of a corporation are managed by or under the direction of its board of directors. It operates to shield from court intervention business decisions which have been made honestly, prudently, in good faith and on reasonable grounds. In such cases, the board's decisions will not be subject to microscopic examination and the court will be reluctant to interfere and to usurp the board of director's function in managing the corporation."⁴⁴

[94]  "It is clear that none of the foregoing authorities imposes a fiduciary duty on majority shareholders or directors in favour of minority shareholders. The case that comes closest to doing so is the Goldex Mines case, which was decided prior to the coming into force of the CBCA in December of 1975, and involved facts which, if they arose at the present time, would appropriately lead to an application under s. 234 of the CBCA or its counterpart, s. 247(2) of the Ontario Business Corporations Act, 1982, S.O. 1982, c. 4 (the OBCA). The enactment of these provisions has rendered any argument for a broadening of the categories of fiduciary relationships in the corporate context unnecessary and, in my view, inappropriate.⁴⁶

[96]  In addition to laying to rest the spector of expanding fiduciary duties, the same judgment of the Ontario Court of Appeal in the Brant case also ruled decisively that a finding that corporate action is oppressive does not necessarily require a concomitant finding of bad faith on the part of directors:

[97]  "I have concluded that evidence of bad faith or want of probity in the actions complained of is unnecessary in an application under s. 234.1 should have been content to arrive at that conclusion merely on the basis of a literal reading of the provision coupled with an application of the statutory objective articulated in s. 4, "to revise and reform the law applicable to business corporations incorporated to carry on business throughout Canada", had it not been for the substantial body of conflicting opinion on this issue cited to us, involving the application of s. 234 or similarly worded provisions in provincial or Commonwealth statutes."⁴⁸

[99]  The case of Westfair Foods v. Watt⁴⁹ may be such a case.  The judge at first instance found that the actions of the directors in approving a trailing dividend policy coupled with a practice of dividending all earnings out and borrowing back from the common shareholders the funds needed to support the corporation's cash flow needs was oppressive.  In finding oppression, the trial judge cited the judgment of first instance in the Brant case as authority for the proposition that a finding of bad faith was not a pre-condition to a recourse based on oppression.  The remedy ordered by the court was that the corporation repurchase the shares held by the complainant on the basis of the court's assessment of their fair market value.  The decision was appealed to the Alberta Court of Appeal.  In dismissing the appeal, Mr. justice Kerans, speaking for the court, noted that he agreed in the result, but disagreed with the finding that the actions of the directors were oppressive.  Instead, Mr. justice Kerans found that the actions of the company "exemplify an unfair disregard for the shareholders".

[100]  The judgment of the Alberta Court of Appeal in Westfair seems to be such as to fall within the rather rare class of cases where relief is awarded under the oppression remedy, but no real substantial fault that might give rise to liability is found with the actions and decisions of the directors.

[101]  In the judgment in first instance in the Westfair case, Chief Justice Moore indicated clearly that the purpose of the oppression remedy was more particularly to protect the complainant from having her interests unfairly disregarded than to find necessary fault with the directors:

[102]  "Indeed, the presence of the terms "unfair prejudice" and "unfair disregard" signal a legislative intent to broaden the scope of circumstances in which the remedy is to be applied.  Furthermore, the express working of s. 241 by focusing on the effect of certain conduct or actions on the complainant's interests suggest a legislative intent to direct judicial enquiry towards the harm sufferred by the complainant and not to the intention or motivation of those responsible for that harm."⁵⁰

[105]  What seems to emerge from the overall body of jurisprudence is a fairly consistent approach to the question of the duties of directors and, in the result, a compelling statement of the importance of the due diligence of directors as the standard to which they are held and, correspondingly, of the due diligence defence as a means for directors to avoid liability for their actions.

[106]  In Blair v. Consolidated Enfield Corp. Mr. Justice Iacobucci, in rendering the judgment of the Supreme Court of Canada affirmed the right of a director to be indemnified in respect of a decision that turned out to be legally wrong but in respect of which the director had exhibited appropriate due diligence.  In concluding, he stated:

[107]  "74. Permitting Blair to be indemnified is consonant with the broad policy goals underlying indemnity provisions; these allow for reimbursement for reasonable good faith behaviour, thereby discouraging the hindsight application of perfection. Indemnification is geared to encourage responsible behaviour yet still permit enough leeway to attract strong candidates to directorships and consequently foster entrepreneurism. It is for this reason that indemnification should only be denied in cases of mala fides. A balance must be maintained."⁵¹

[109]  Also emerging from the jurisprudence with equal clarity is evidence of a strong linkage between the statutory provisions related to the liability of directors and the jurisprudence.  An appreciation of that linkage can be seen in the seminal Supreme Court of Canada case of R. v. City of Sault Ste-Marie⁵² where Mr. Justice Dickson wrote:

[110]  "It may be suggested that the introduction of a defence based on due diligence and the shifting of the burden of proof might better be implemented by legislative act. In answer, it should be recalled that the concept of absolute liability and the creation of a jural category of public welfare offences are both the product of the judiciary and not of the Legislature. The development to date of this defence, in the numerous decisions I have referred to, of Courts in this country as well as in Australia and New Zealand, has also been the work of Judges. The present case offers the opportunity of consolidating and clarifying the doctrine."⁵³

[112]  "Having concluded that the words [of the oppression provisions] charge the courts to impose the obligation of fairness on the parties, I must admit that the admonition offers little guidance to the public, and Parliament has left elucidation to us. I have elsewhere said that I take this sort of indirection as legislative delegation. See Transalta Utilities Corporation v. Alberta Public Utilities Board (1986), 43 Alta. L.R. (2d) 171 at 180."⁵⁴

[114]  It is against this overall backdrop, and the historical interplay between the legislator and the judiciary that the relative importance of the current reform of directors' liability under the Canada Business Corporations Act must be judged.  The relatively modest amendment to s. 123(4) and the addition of 123(5), must be seen as one more  graceful step on the part of Parliament in this continuing pas de deux with the courts in pursuit of fair and balanced treatment for Canadian directors.

[115]  Whether it is the voice of the Supreme Court of Canada stating that the principles applied by the courts are geared to "... foster entrepreneurism..."⁵⁶ or the words of the legislator stating that the reform of directors' liability law in the Canada Business Corporations Act is designed to ensure "... the entrepreneurial strength and the competitiveness of Canadian corporations..."⁵⁷ the message is the same, it is consistent, and it is clear: Canadian directors fulfil their responsibilities and may be called to account under a body of rules that is coherent, fair and reasonable, recognizing that so long as directors act reasonably, honestly and in the best interests of the corporations they serve, they will not be held liable for their business decisions.

[116]  A word of caution on American precedents

[117]  The danger of relying on American precedents in matters of corporate governance was alluded to earlier in this paper.⁵⁸  Indeed, superficial similarities between the principles that apply in Canada and those that apply in the United States make it tempting to rely on American precedent to resolve issues that arise in Canada.  Given the cornucopia of American jurisprudence, finding a case that seems to provide a fit solution to any given Canadian dispute is rather more likely than not.  Yet there is substantial risk in that reliance.

[118]  "Although many of the fads and fashions in the American debate over corporate governance have crossed the border, in many respects the parallel Canadian debate is profoundly different from that in the United States. In large part this is attributable to core differences in the underlying structure of markets, as well as in the organization of law and legal institutions operating in the two countries."⁵⁹

[121]  One area where there is a particularly acute concern is with the "business judgment rule".  This is a term that, as noted above, is used increasingly by Canadian judges and authors to describe the deference that Canadian judges accord to the business decisions of directors.

[122]  In the United States, the business judgment rule is an institution with very deep roots and with a very detailed set of rules and consequences.   Designed as a shield to prevent the second-guessing of directors' business decisions, the American business judgment rule is not so much about the standard of care that directors bring to their decisions (as is the case in Canada) but more about the process that directors follow.

[123]  Like many other areas of American law, the business judgment rule is a "safe harbour" designed to avoid an enquiry into the director's standard of care.  If a director can bring herself within the safe harbour, no liability will attach.

[124]  "Notwithstanding these and other proposals for reform, certain elements have emerged as the core of the business judgment rule.  First, the rule always includes the following key concepts: (i) a business decision, (ii) made in good faith, (iii) by disinterested parties, (i.e., no self-dealing or self-interest), (iv) based on informed judgement, and (v) with a belief (often described by a subjective or objective qualifier such as "reasonable," "rational," or "honest") that the action taken is in the best interests of the corporation.  Second, the rule always has two related and complementary aspects:  that directors will be presumed to have acted properly and that a court will not second guess the business merits of a business decision. Finally, the rule operates in two basic contexts: to protect a business decision from attack, and to protect individual directors from monetary liability."⁶⁰

[126]  To the extent that one probes further, the rule appears in a fuller light and one begins to see how very different its operation really is.

[127]  For one thing, the rule is fundamentally concerned with "process" not "substance".  So even though the rule, as it is most often expressed, requires that the directors exercise due care (in Canada equivalent to due diligence, and therefore inviting an enquiry related to the standard of care that the directors exhibit in their decision-making behaviour), the American due care requirement is purely procedural and turns on whether the directors were "informed".  That the directors acted imprudently and failed in their duty of due care is not relevant to the result:

[128]  "The duty of care, as applied by the courts to a director's decisions, is intimately linked to, and constrained by, the business judgment rule, a doctrine limiting the liability of a director in the good faith pursuit of his duties.  Under that rule, so long as a director acts in good faith and with due care in the process of decision-making, the director will not be found liable even though the decision itself was not one that would have been made by an ordinarily prudent person.  Therefore, because application of the business judgment rule prevents the imposition of liability, and the care element of the rule is solely process, the duty of care in the decision making context is process due care alone."⁶¹

[130]  Where the doctrine gets to be really very interesting is when the plaintiff succeeds in convincing the court that the directors' decision was not sufficiently informed.

[131]  One of the process requirements is that the business decision be on the basis of informed judgment.  It is said that the plaintiff's burden of proof requires that the plaintiff show that the directors were essentially grossly negligent in informing themselves in relation to the matter at hand.

[132]  A director could certainly be forgiven for feeling himself to be reasonably safe in such circumstances.  Yet the risk is enormous.  For in the event that the plaintiff persuades the court that the decision was not sufficiently informed, the burden then shifts to the directors to prove to the court, in the harsh light of hindsight, that the decision they reached was entirely fair to the corporation and its shareholders.

[133]  "If the challenger produces evidence sufficient to rebut the presumption, the burden shifts to the directors to justify the decision as entirely fair to the corporation. The degree of culpability required to defeat the presumption is said to be gross negligence of the directors in Delaware, but is different in other states. Once the presumption is rebutted, directors face an exacting standard which requires rigorous judicial scrutiny of the transaction’s fairness.”⁶²

[135]  Even before focusing on what it might mean for a director to have to prove that a transaction was "entirely fair", it is very important to pause and to consider just what is meant by the "gross negligence" standard.  What one finds when one does, is one of the ghastly little aspects of the American business judgment rule: American courts seem not to have a very good grip on what constitutes gross negligence:

[136]  "In the face of the somewhat confused state of the law on the subject of gross negligence, its definition and its application, the reader is lead to a conclusion that, in this context, gross negligence "means simply a failure to use such amount of care as an ordinarily prudent man in a like position would use under similar circumstances, and 'a failure to conform to this standard could be held to constitute gross negligence.'"⁶³

[139]  What obtains on balance under the American business judgment rule seems, in the result, to be a kind of tripwire standard of care whose intensity varies from one of reasonableness, to one of perfect fairness in hindsight, like whiplash.

[140]  The first crack of the whip came with the decision of the Supreme Court of Delaware in the case of Alden Smith v. Jerome Van Gorkom:⁶⁵

[141]  "We conclude that Trans Union's Board was grossly negligent in that it failed to act with informed reasonable deliberation in agreeing to the Pritzker merger proposal on September 20; and we further conclude that the Trial Court erred as a matter of law in failing to address that question before determining whether the directors' later conduct was sufficient to cure its initial error."⁶⁶

[143]  The Van Gorkom case singlehandedly caused a forest to be felled in support of the commentary that ensued.  One such comment came from a prominent member of the New York bar:

[144]  "The Delaware Supreme Court in Van Gorkom exploded a bomb. Stated minimally, the court there pierced the business judgment rule and imposed individual liability on independent (even eminent) outside directors of Trans Union Corporation because (roughly) the court thought they had not been careful enough, and had not enquired enough, before deciding to accept and recommend to Trans Union's shareholders a cashout merger at a per-share price that was less than the "intrinsic value" of the shares. The case was remanded to determine the amount of damages. Of the six Delaware judges who sat on the case, three agreed with the defendant directors, but (unfortunately for them) one of the judges who favored their side was the lower court. The dissent in Van Gorkom was vigorous. The corporate bar generally views the decision as atrocious. Commentators predict dire consequences as directors come to realize how exposed they have become."⁶⁷

[146]  As recently as 1993, the Delaware Supreme Court reminded directors of the risk that their office entails.  The court recently affirmed and applied the decision in the Van Gorkom case in the case of Cede & Co. and Cinerama, Inc. v. Technicolor, Inc.:

[147]  "Applying Van Gorkom to the trial court's presumed findings of director and board gross negligence, we find the defendant directors, as a board, to have breached their duty of care by reaching an uninformed decision on October 29,1982, to approve the sale of the company to MAF for a per-share sale price of $23. We hold that the plan of merger approved by the defendant directors on October 29, 1982, must, on remand, be reviewed for its entire faimess, applying Weinberger. 457A.2d at 711.

[148]  We think it patently clear that the question presented is not one of first impression, as the court below appears to have assumed. Applying controlling precedent of this Court, we hold that the record evidence establishes that Cinerama met its burden of proof for overcoming the rule's presumption of board duty of care in approving the sale of the company to MAF. The Chancellor's restatement of the rule - to require Cinerama to prove a proximate cause relationship between the Technicolor board's presumed breach of its duty of care and the shareholder's resultant loss - is contrary to well-established Delaware precedent, irreconcilable with Van Gorkom, and contrary to the tenets of Unocal and Revlon, Inc. v. MacAndrews & Forbes Holdings, Del. Supr., 506 A.2d l73 (1986). More importantly, we think the court's restatement of the rule would lead to most unfortunate results, detrimental to goals of heightened and enlightened standards for corporate govemance of Delaware corporations."⁶⁸

[150]  "The more interesting, and certainly less obvious, effects of Cede are the jurisprudential meanings that the decision has implicated. As stated in the previous section of this Comment, Delaware is changing the liability standards applied to directors in duty of care challenges. But it is not enough to say that these standards have moved away from gross negligence and toward strict liability. The question remains: What will be the impact of this reformulated doctrine of law? And, as an initial matter, why has this change occurred?"⁶⁹

[152]  "The fact that Crystal did not quantify the potential severance benefits to Ovitz for terminating early without cause (under the terms of the Employment Agreement) does not create a reasonable inference that the Board failed to consider the potential cost to Disney in the event that they decided to terminate Ovitz without cause. But, even if the Board did fail to calculate the potential cost to Disney, I nevertheless think that this allegation fails to create a reasonable doubt that the former Board exercised due care. Disney's expert did not consider an inquiry into the potential cost of Ovitz's severance benefits to be critical or relevant to the Board's consideration of the Employment Agreement. Merely because Crystal now regrets not having calculated the package is not reason enough to overturn the judgment of the Board then. It is the essence of the business judgment rule that a court will not apply 20/20 hindsight to second guess a board's decision, except "in rare cases [where] a transaction may be so egregious on its face that the board approval cannot meet the test of business judgment." Because the Board's reliance on Crystal and his decision not to fully calculate the amount of severance lack "egregiousness," this is not that rare case. I think it a correct statement of law that the duty of care is still fulfilled even if a Board does not know the exact amount of a severance payout but nonetheless is fully informed about the manner in which such a payout would be calculated. A board is not required to be informed of every fact, but rather is required to be reasonably informed. Here the Plaintiffs have failed to plead facts giving rise to a reasonable doubt that the Board, as a matter of law, was reasonably informed on this issue."⁷⁰

[155]  The net result of the foregoing brief analysis can only leave Canadian jurists with the clear impression not only that there are important distinctions to be made between the rules that apply in Canada as regards the liability of directors and those that apply in the United States, but that the rules are in practice fundamentally different.

[156]  In addition to the fundament difference in terms of the standard of care and the degree of deference granted to business decisions, there are other more subtle differences as well.  To cite but one small example, the U.S. business judgment rule protects at one and the same time the director from liability, and the underlying business decision from judicial review.  The business decision and the directors' liability are thus intertwined in the American business judgment rule.  We have seen that in Canada the courts have determined that remedies may be available to a complainant (i.e. the court will interfere with a business decision) but without necessarily attaching liability to the directors.⁷¹  This rather small and subtle distinction may prove to be an important factor in mitigating directors' liability in Canada without by the same token denying remedies to stakeholders who otherwise may have a case to make that their interests have been unfairly disregarded.

[157]  A sword more often than a shield

[158]  On the final note of this cautionary tale, it is interesting to see that when a party suggests that a Canadian court apply U.S. precedent to the case at bar, it is often with a view to invoking the liability of directors rather than for the purpose of mitigating or tempering the liability.  To date, Canadian judges have shown admirable restraint and have often resisted the temptation.  Two cases where the bait was offered are Maple Leaf Foods v. Schneider Corporation et al⁷² and CW Shareholdings Inc. v. WIC Western International Communications Ltd.⁷³   In the Maple Leaf Foods case the judge considers the American precedents and the Canadian precedents and appears to find them equivalent, in the end, applying the Canadian rule.  In the CW Shareholdings case, the plaintiff was more forceful, and the court considered the American cases in somewhat more detail, in the end declining the apply the American rule and preferring the Canadian formula.

[159]  Unfortunately, the American authorities on the business judgment rule are too often cited in Canadian corporate governance doctrine⁷⁴ but without the detailed analysis that is needed in order to allow the reader to appreciate the important differences that make the U.S. precedents difficult to apply in the Canadian context.

[160]  Conclusion

[161]  The amendments to Canada Business Corporations Act adopted by Paliament in June of 2001 make an important contribution to the coherent and reasonable scheme of directors' and officers' liability that applies in Canada.  The amendments dovetail nicely with the policies on corporate governance and director oversight evident in the jurisprudence of Canadian courts and the periodic governance reviews carried out by our self-regulatory organizations. Perhaps most importantly, the amendments are consistent with the Canadian tradition of codifying the common law elaborated by the courts and thus preserve an approach to this question that is appropriate for the Canadian context, and that is therefore, in some measure, uniquely Canadian.

[162]  In this way the amendments do not in any way encourage, much less promote, reference to, and reliance on, American precedents related to the liability of directors and officers that result in a scheme of liability that is, to significant degree, arbitrary in its results.  Such reliance would likely result in a degree of risk exposure that, if it prevailed in Canada, would definitely run against the widely-accepted policy objective of avoiding the "liability chill" that would tend to undermine entrepreneurial risk-taking and tend to deprive corporations of the very talent that they need when they need it most, when the risks to be managed are most pressing.

[163]  It is fitting that I leave the last word on this topic to Red Wilson⁷⁵ whose testimony before the Kirby Committee was cited with approval as summing up the policy on directors' liability in Canada:

[164]  "In addressing directors' liability, we must ensure that capable men and women are encouraged to serve.  Aside from large, well-financed, profitable, well-insured corporations, they should also be motivated to sit on the boards of other entities which need their assistance including corporations whose success is essential to job creation and the economy of Canada.

[165]  The challenge... is to achieve an appropriate balance.  The most able individuals must be encouraged to act as directors, to support reasonable business risk-taking to further the interests of the corporation, and to be diligent in discharging their duties.  At the same time, these same individuals should not be exposed to unreasonable potential risk"⁷⁶