The role of Information in Corporate Governance

David G. Masse1
© 1999


Text of a lecture presented in Montreal, Quebec on September 29, 1999 at the Second Quebec Summit on Corporate Governance organized under the auspices of the Institute for International Research and in Toronto at the Annual Conference of the Canadian Society of Corporate Secretaries on October 21, 1999

Table of Contents

[1]  Introduction

[2]  The world we know and experience daily, as tangible as it may be in its concrete, steel, glass, plastic and silicon expression, is nothing more than the embodiment of ideas, or systems of ideas, whose existence was once entirely virtual. The board of directors of a modern corporation, perhaps more than any other institution, serves as a crucible for transforming mere ideas into tangible, and irrepressible economic reality.

[3]  The purpose of this presentation is to consider how a board of directors serves its purpose in the context of the legal obligations of directors and, ultimately, to explore the role played by the flow of information to and from the board of directors.  This paper examines the potential of today's information technology to increase the efficiency of decision-making at the level of the board of directors of the enterprise, and provides an in-depth consideration of the impact on directors' liability that may be expected if information technology is used to enhance dramatically the flow of information to the board of directors. The concrete steps that can be taken to make use of information technology in this context are also examined.

[4]  The Role of the Board of Directors

[5]  The modern board of directors owes its existence to a complex and very rich source of socio-economic and historical factors.

[6]  While the board of directors, as we know it, is a relatively modern institution, it is built upon the committee, a social structure as old as mankind.  The modern corporation we know today, with a personality distinct from that of its directors and members, dates back to late 15th century England and Europe, having evolved from the notion of the distinct personality of early municipal governments that had begun to take shape as far back as the late 13th century.2   While we tend to think of the modern corporation as an invention of the industrial revolution, it has, in fact, evolved remarkably slowly and steadily over a considerable length of time, continually adapting itself to changing social and economic circumstances.

[7]  A constant accompanying factor in that evolution, has been the continual improvement of technology.  From the loom to the mill, to the mass mechanisation of the industrial revolution, and now, to the bitstream of the information age, the corporation has adapted very well to serve the needs of an ever more complex society.  Indeed today, it is one of the most important of our institutions.

[8]  The social and economic role played in our society by enterprises managed by boards of directors3 is unparalleled in historical terms, and immensely important in producing the goods and services that we rely on daily.4  The board of directors also serves a key role in creating and maintaining the store of sustainable value that society needs for its short term and long term survival.  The importance of that role accounts for the rules that the law has developed as a framework for company directors and the boards they serve.

[9]  The board of directors has great strengths but also potential weaknesses.  The great value of the board of directors as an institution lies in the synergy that accompanies the concerted work of many good people, allied to a common goal, for the greater good of the business enterprise they serve.  The potential weaknesses stem, for the most part, from the mirror of the strengths.  Properly aligned for the good of the corporation, the  board of directors is well positioned to deliver all the growth and sustenance of value that a business enterprise is capable of producing.

[10]  The Role of the Law

[11]  The body of laws governing the behaviour of directors, like the institution that it governs, flows from a varied and rich source.5

[12]  The law as it exists today in most jurisdictions is aimed at ensuring that the board of directors functions as it is meant to.  Taken as a whole, our laws tend towards the making of decisions that militate in favour of creating or maintaining value for the enterprise and its stakeholders.6

[13]  While the corporation is primarily a creature of statute, directors are in some sense fiduciaries of their offices and accordingly, the equitable rules that have developed over time in common law jurisdictions have played, and continue to play, an important role in framing the rights and obligations of directors.  They are fiduciaries in the sense that the patrimony that they administer does not belong to them, and ultimately, is the common pledge7 of the various stakeholders interested in the corporation's success.  The relationship of the directors to the corporation is therefore treated, in some important respects, as if the patrimony of the corporation were entrusted to their care.

[14]  While the civil law does not draw upon equity in the same way as the common law does, the rights and obligations of directors in civilian jurisdictions, such as Québec, similarly flow from a mixture of sources and do not rest exclusively on the governing statute to which the particular corporation owes its existence.8

[15]  The role of law in society is to provide a framework to ensure that our most basic and fundamental expectations of society and its institutions are met. The law serves its end by defining society's expectations, usually explicitly, but often implicitly as well, and by  imposing sanctions that apply when our expectations are not met.  In matters related to our financial and business expectations, the primary sanction imposed by the law is pecuniary, in the form of fines owed to the state, and civil liability incurred to third parties.  For the most serious breaches, penal consequences also apply.

[16]  Of all the legal sanctions, the threat of civil liability is the one that most informs the laws that provide the modern framework for corporate governance, and that buttresses society's expectations of corporate directors very effectively.  The trend towards imposing more and more sources of liability on corporate directors has evolved since the late 1970's.  The single most fertile source of liability has been the multiplication of statutory provisions imposing liability on directors:

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

[18]  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."9

[19]  The trend towards more pervasive liability for directors has not been solely the province of the legislatures.  The courts have also played a very active role:
[20]  "A major development during the last 20 years has been the expansion by the courts of the persons to whom fiduciary duties and/or duties of care are owed.  Traditionally, in Canada, directors have owed fiduciary duties only to the corporation and not to shareholders.  However, recent cases have held that directors may be responsible in some circumstances to shareholders, other investors, and, even in some cases, the government for breaches or either duties of care or loyalty and good faith.  There seems to be an increasing tendency to name directors in suits between corporations for breaches of contract.  Most of these cases, though, relate to the private company setting where the director is also an owner-manager."10
[21]  The threat of civil liability is indeed a powerful incentive in ensuring that corporate directors perform their duties in the best economic interests of the corporations they serve, and it is generally recognised that this is an appropriate policy for the government and the courts to pursue.11   It is important to remember, however, that a reasonable balance must be maintained between the incentive to serve and the dis-incentive of avoiding undue risk, if society wants to attract qualified and experienced business leaders to serve on boards of directors.  Failure to maintain that balance can, in the end, cause substantial economic harm by undermining the important role that corporate boards of directors play in our society.12

[22]  The Role of the Commercial Imperative

[23]  Although legal rules play a very important role in providing a framework for the activities of the board of directors, the law recognises that the primary mission of the board is to manage and to grow the company's business.13   The business literature on corporate governance understandably focuses to a great extent on the business function of the board of directors and the processes that contribute to the commercial success of the business.  It is increasingly felt, for instance, that the board of directors should abstain to the greatest extent possible from focusing on day-to-day management issues and should concentrate instead on overall corporate strategy and succession planning, with particular emphasis on leading economic indicators, competitive analysis, customer satisfaction and employee satisfaction.14   To the extent that the very limited time available for the deliberations of the board of directors is allocated to those kinds of concerns, the authors suggest that less of the valuable meeting time be devoted to historical financial information and to the approval of operational decisions:

[24]  "Anything that is purely informational or pro forma (not expected to require any discussion, such as routine dividend payments, approval of auditors, or other compliance issues) should be sent to board members ahead of time and handled quickly at the beginning or end of the board meeting or, when possible, telephonically.  Praxair CEO Bill Lichtenberger said, "in this age of telecommunications and video conferencing you can pull the whole board together from any place in the world for a telephone conference.  I just had one last night!"

[25]  Royal Bank of Canada uses a consent agenda to free up meeting time for matters of strategic importance.  The consent agenda includes "housekeeping items," such as routine executive appointments or certain smaller capital expenditures that can be explained on paper.  Jane Lawson, senior Vice-President and Secretary of Royal Bank of Canada, explains: "The consent agenda is circulated prior to board meetings as part of a comprehensive package of information and executive summaries relating to matters to be dealt with at the meeting.  Any director who wishes may move any of the matters slated for the consent agenda onto the main agenda for board discussion.""15

[26]  To a certain extent the business conception of the board of directors is paradoxically at odds with the legal conception.16   Few understand, for example, that while the indoor management rule17 protects third parties who deal with officers and employees who have the ostensible authority to bind the corporation, the right of officers and employees to administer the affairs of the corporation is limited to the express authority vested in them by the board of directors.   The legal framework therefore requires that all management decisions be taken directly by the board of directors,18 or be taken by persons to whom authority has been explicitly delegated by the board of directors.  Any employee who acts without explicit authority does so at his or her own peril. In the case of virtually all important transactions, the relying party will most often refuse to rely on the indoor management rule, and will insist on tangible evidence that the board of directors has explicitly authorised the transaction.

[27]  Efficient use of the limited resources of the board of directors therefore requires that the legal framework and the business framework be reconciled so that they work in harmony.

[28]  This is most simply accomplished when the board of directors adopts one or more standing authorisations that delegate to the management team the administration of the enterprise's business in the ordinary course.   The board can therefore determine, and eliminate from its agenda, most classes of business that need not concern it.

[29]  The resolutions adopted by the board of directors, whether they concern the approval of a specific transaction or the pre-approval of broad classes of transactions that are routinely entered into in the ordinary course of the enterprise's business, are examples of vital information flowing out from the board of directors to management, and ultimately, to the other stakeholders as well.

[30]  In order to support its decisions with respect to matters that are not in the ordinary course of business, or with respect to the dissemination of information concerning the performance of the corporation, information must flow in the other direction, to support the decision-making process.

[31]  The Board Process

[32]  At the heart of the role played by the board of directors is the board process in which information flows to and from the board.

[33]  Decision-making processes work in the fashion of an adaptive loop:

[34]  "The loop consists of four steps: sense, interpret, decide, and act.  This model is continuous, and emphasises that the environment may have changed since the last cycle and that, in acting, we alter the original environment, and thus need to begin sending again."19
[35]  Information is the raw material that is sensed, interpreted and acted upon by the board process, that is to say the process that moulds information into the decisions that are the impetus for all corporate action. Good decisions depend on good and timely information.  The information on which decisions are based flows primarily from the management team,20 and to a lesser extent from other stakeholders.21

[36]  While some items of business submitted for the consideration of the Board of Directors recur cyclically, such as the consideration of the enterprise's financial condition, the review of the results of operations, the approval of financial statements and the declaration of dividends, the bulk of the remaining items are made up of special business, such as the acquisition or divestiture of assets and investments, the approval of financial transactions or the consideration of business alliances, among others.

[37]  In each case, management generally provides information to the directors in advance of the meeting.  The information provided most often consists of financial statements or reports related to the results of operations, as well as presentations, executive summaries, draft resolutions, and sometimes draft documentation that will be submitted for the directors' consideration.22

[38]  Historically, the flow of information to the board of directors has been, in large measure, determined by the limitations of ink and paper.  While the introduction of facsimile transmission in the mid 1980's, and its subsequent proliferation, had an important impact on management's ability to provide information to the directors, the advent of the Internet and more particularly of the World Wide Web, is transforming, in a far more important and fundamental way, the quantity, quality and variety of information that can be delivered.   The importance of the change is of such an extent that it is difficult to grasp, and virtually impossible to foresee, the impact that information technology will have on the ways that a board of directors goes about its business.

[39]  Unlike paper-based information, digital information is, for all intents and purposes, volume insensitive, format independent, and time and distance independent. Our ability to store and to move text bytes in distributed computer networks is nothing short of awesome.  The combined records of the board of directors of a century-old public company fit comfortably on a single CD-ROM.  All of any corporation's records of all kinds may now be easily published on an Intranet.  Spider-based search tools can index and catalogue the entirety of just such an immense collection of information, and allow information to be mined and used as a real-time decision resource.

[40]  In short, it is now possible to find the needle in the haystack. Easily. Quickly.

[41]  At the present time, Internet protocol technology is not in widespread use as a means to support the decision-making process for boards of directors.  The board process remains, for the majority of public corporations, a traditional, paper-based process.  The limitations of the existing process are well-known, and the courts have had ample opportunity to consider and to develop standards for the care to be exercised by corporate directors in fulfilling the obligations they owe to the companies they serve.

[42]  It is inevitable that information technology will be harnessed in the service of the board process.

[43]  What impact will be felt when the limits on the availability of information are substantially removed?

[44]  Is a director entitled to rely only on information explicitly provided by management? To what extent does a director have an obligation to make independent inquiries?23  In an environment where virtually all information could be made available online, is there an argument for limiting the information available to a director? If virtually all information concerning a corporation was available on its Intranet and was full-text searchable, without restrictions, would a director be obliged to investigate general Intranet resources, other than those specifically destined for directors?

[45]  To date, some of these questions have not been posed, yet the answers will become more and more important as Internet protocol information technology becomes more and more pervasive in business implementations.  If Intranet technology is in widespread use in the operations of a company, is it not reasonable to bring it to bear in the board process?24  These questions will therefore tend to come to the fore, whether or not a conscious decision is made, in the case of any particular board of directors, to enlist the power of the Internet in the board process.

[46]  The Rights and Obligations of Directors as they Relate to Information

[47]  In order to answer the questions posed above, it is necessary to consider in some detail the source of directors' duties.  In doing so I will consider the situation of the director of a corporation incorporated under the Canada Business Corporations Act.25   The legal duties of directors serving corporations under the laws of most jurisdictions in Canada will be substantially the same, though there are some minor differences in the way that liability is framed in some jurisdictions.26

[48]  We saw earlier that directors are charged by law with the management of the affairs of the corporation.  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:

[49]  Power to manage

[50]  s. 102. (1) Subject to any unanimous shareholder agreement, the directors shall manage the business and affairs of a corporation.

[51]  Officers

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

[53]  (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);

[54]  Duty of care of directors and officers

[55]  122. (1) Every director and officer of a corporation in exercising his powers and discharging his duties shall

[56]  (a) act honestly and in good faith with a view to the best interests of the corporation; and

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

[58]  The statutory duty thus expressed is, in large measure, a codification of the duty of care that the common law courts had developed over time and remains substantially as expressed in the leading case of In re City Equitable Fire Insurance Company Limited.27   Mr. Justice Romer described the general principles that he had distilled from the reported cases and that he would apply to the case before him, as follows:
[59]  "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.  It is perhaps only another way of stating the same proposition to say that directors are not liable for mere errors of judgment.  (2.) A director is not bound to give continuous attention to the affairs of his company.  His duties are of an intermittent nature to be performed at periodical board meetings, and at meetings of any committee of the board upon which he happens to be placed.  He is not, however, bound to attend all such meetings though he ought to attend whenever, in the circumstances he is reasonably able to do so.  (3.) In respect of all duties that, having regard to the exigencies of business, and the articles of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly."28
[60]  The key to determining the extent of directors' obligations as they relate to the information upon which they must rely in exercising their duty to manage, lies in the third branch of the duty as expressed by Mr. Justice Romer, and in the provisions of s. 121 of the Act.

[61]  It is 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 entitlement to rely, of necessity, must extend to the obtention of information on which the board of directors must base its decisions. The judgment of the English Court of Appeal in In re National Bank of Wales, Ld.29 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:

[62]  "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."30
[63]  It follows that directors do not have a duty to enquire and to obtain information on their own, so long as it is reasonable for them to rely on management.  The jurisprudence and doctrine on corporate law provide a substantial amount of guidance on the limits of directors' entitlement to rely on management:
[64]  "First, as discussed earlier in this chapter, directors are entitled to delegate many of their managerial duties to internal management and to board committees.  Although, as noted by Romer J. in Re City Equitable Fire, directors are not bound to give  continuous attention to the affairs of the company, they must exercise due care in selecting competent officers.  To the extent that delegation of duties to internal management is permitted, directors are justified, in the absence of grounds for suspicion, in trusting that the person to whom the duty is delegated will perform it honestly and competently.  While this principle should provide comfort to directors, the caveat should be noted.  Where there are grounds that would lead a reasonable person in comparable circumstances to suspect a problem, a director will be in breach of duty for failing to make the necessary inquiries."31
[65]  The director's duty to enquire into the affairs of the corporation actively and to obtain information directly, without reliance on management, only arises where the director is put on notice by circumstances that come to his or her attention.  Most of the jurisprudence in this regard has arisen under tax statutes that impose personal liability on directors for the failure to remit taxes that the corporation was bound to collect.32

[66]  Thus, directors will be held to have failed in their duty of care in the circumstances shown in the following cases.  These cases exemplify the "rotten wood" approach: once there is cause for suspicion, the director's duty is to enquire and to seek information until such time as the extent of the problem has been reasonably well diagnosed.  The failure to pursue enquiries sufficiently will generally be a ground of liability:

[72]  This is not to say that directors may simply turn a blind eye to the affairs of the corporation and thus escape liability.  They must exercise reasonable diligence in exercising their duties.  To the extent that they are guilty of wilful blindness, they run the risk of liability.33

[73]  The leading case in Canada that relates to directors' liability under taxation statutes is the decision of the Federal Court of Appeal in the case of Soper v. Canada.34  The judgment of the Court was rendered by justices Marceau, Linden and Robertson JJ.A.  Mr. Justice Robertson reviewed the case law, doctrine and statutory provisions in detail, both under the Income Tax Act and the Canada Business Corporations Act and reaffirmed in unequivocally strong terms the principle that directors, whether their liability arises under the corporation statute or under the Income Tax Act are entitled to rely on management for the information upon which they act. Where grounds of suspicion arise, their entitlement to rely ceases, and directors are then well advised to make enquiries.  The Court indicated in this regard that in making enquiries, directors ought to rely on independent third parties who are expert in the matter to which the enquiry relates.

[74]  The Soper Court's view that directors who find themselves in circumstances that impose a duty to enquire into the affairs of the corporation ought to rely on independent experts arises in part from the provisions of the Canada Business Corporations Act.  While the Act does not provide a general due diligence defence to directors, it does allow directors to avoid liability where they rely on experts:

[75]  Reliance on statements

[76]  123. (4) A director is not liable under section 118, 119 or 122 if he relies in good faith on

[77]  (a) financial statements of the corporation represented to him 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

[78]  (b) a report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by him.

[79]  The Supreme Court of Canada recently considered the reliance of directors on expert advice in the case of Blair v. Consolidated Enfield Corp.35   Mr. Justice Iacobucci reviewed the jurisprudence, stating:
[80]  "In deciding not to reject the advice of counsel, Blair in fact fulfilled his fiduciary duty.  Consequently, I would disagree with Holland J. to the extent that he held otherwise in a series of obiter comments not necessary to the resolution of the question before him (i.e. whether, upon their true construction, the proxies were validly voted).

[81]  The appellant cites some case law in favour of the proposition that reliance on legal advice in and of itself does not entitle an officer or director to indemnification: Central & Eastern Trust Co. v. Rafuse, (sub nom. Central Trust Co. v. Rafuse) [1986] S.C.R. 147; Exco Corp. v. Nova Scotia Savings & Loan Co. (1987) 35 B.L.R. 149 (N.S.T.D.).  Although this principle is found in the jurisprudence, it is not really relevant to the case at bar, given that the decision to permit Blair to be indemnified is not grounded in and of itself in Blair's reliance on the erroneous advice yet, instead, takes root in several considerations, such as the fact that he did not breach his duties as chairman, and is further coloured by the fact that the reliance on Osler's advice was fully made in good faith.  I note that the case law cited by the appellant establishes that reliance on counsel's advice (even if it leads to a deleterious result) will strongly militate against a finding of mala fides or fiduciary breach, such a finding being necessary to disentitle one from indemnification.  For example, in Exco at pp. 220-21, Richard J. held:

[82]  The presence of… counsel… does have the result of absolving the directors of any allegation of bad faith with respect to their actions.  Directors have a right, indeed a duty to rely on the opinion of counsel.…
[83]  Although what the directors did, as a board, may have been unlawful, no liability can attach to the directors personally for what they did, having first received advice from… counsel who held himself out as having experience and expertise in that area of the law. [emphasis added.]
[84]  And, in Rafuse, supra at pp. 215-16, Le Dain J. held:
[85]  The executive officers of the… Company and the members of the Executive Committee of the Board of Directors did not have a duty of care with respect to the legal aspects of a transaction other than to retain qualified solicitors to perform the necessary legal services. …  They might well have been negligent had they relied on their own legal judgment in such a case.  … the trust company "took the only course open to it to determine the validity of the mortgage, namely, consulting the solicitors."
[86]  It was reasonable for Blair to believe, and the evidence shows he did believe, that reliance on the advice of Osler was the only course open to him.  Thus, it is clear that Blair fulfilled his duty of care under the Rafuse standard.  This militates against a finding that he should not be indemnified for the subsequent litigation initiated by Canadian Express.  I also note that such a conclusion is consonant with jurisprudence in other contexts which has held that reliance on actuarial and legal advice obtained from competent sources would militate against a finding of misconduct: Bathgate v. National Hockey League Pension Society (1994) 16 O.R. (3d) 761 (C.A.), leave to appeal to the Supreme Court of Canada refused, [1994] 2 S.C.R. viii (for trustees); C.M.S.G. v. Gagnon [1984] 1 S.C.R. 509, at p. 532 (a union's decision not to take a grievance to arbitration)."36
[87]  Once directors determine that they must rely on expert advice, the role of gathering the information on which the expert advice will be given falls to the expert, not to the director.  The obligation of the director being limited to ensuring that the expert is given access to the information:
[88]  "Directors should ensure that the expert in question is properly qualified, that the advice to be given is within the scope of his or her particular expertise, and that the expert has been given access to all information in the possession of the corporation that is relevant to the matter in issue."37
[89]  The result that obtains in Canada is, in the end, similar to the result in the United States.  One must exercise caution however when referring to American precedents because the law of directors' liability in the United States is often not directly applicable in Canada owing to important differences in certain areas.38  This is notably the case as regards the information on which directors must act.

[90]  Under American law, directors may be shielded from liability in respect of their business decisions by the doctrine known as the business judgment rule.  The business judgment rule applies a principle similar to that expressed in the Equitable Fire case discussed earlier, to the effect that "directors are not liable for mere errors of judgment."39

[91]  "While a court will not substitute its own business judgment for that of directors and officers, it will examine the decision-making process closely in order to determine whether the judgment in question was exercised honestly, and with proper diligence, in the corporation's best interests and on the basis of all material information reasonably available to the directors."40  [Underlined emphasis added]
[92]  The American business judgment rule may simply be stated as follows:
[93]  "The business judgment rule, as stated by the Delaware courts, is "a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company."41  [Underlined emphasis added]
[94]  In order for directors to enjoy the protection afforded by the presumption they must show, inter alia, that they acted on an informed basis. This duty to be informed is also explicitly reflected in the formulation of the duty of care under certain American corporation statutes, and is implicitly recognised by the courts in jurisdictions where the directors' duty of care is formulated without an explicit reference to the obligation to act on an informed basis.42   This imposes an obligation in most jurisdictions in the United States for directors to make enquiries.

[95]  The extent of the duty to enquire may be stated as follows:

[96]  "Busy directors and officers are often interested in how much information they must seek in their corporate decision-making and in order to satisfy the general standard of care.  What is their duty to inquire about corporate activities?  Two Delaware cases, Graham v. Allis Chalmers Manufacturing Co. [188 A. 2d 124 (Del. 1963)] and In re Caremark International Inc. Derivative Litigation [698 A. 2d 959 (Del. Ch 1996)] that re-interpret Graham, are particularly noteworthy.

[97]  The classic 1963 Graham case questioned whether directors in a large and diversified corporation are responsible for antitrust violations by lower-level managers - based on the theory that the director's lack of monitoring and lack of inquiry into corporate affairs constituted a breach of their duty of care.  The directors had neither direct knowledge nor had participated in the wrongdoing.

[98]  The Delaware Supreme Court concluded that the directors did not have a duty to inquire "under these circumstances."  The court would impose such a duty only when the directors are "on notice," which does not occur until they are somehow made suspicious that there might be problems.  In other words, this case suggested that directors' legal obligation to seek out problems or take preventive action appear quite minimal.  They are entitled to rely on the honesty and integrity of subordinates in providing them with the relevant information and raising potential problems.

[99]  The more recent Caremark case suggests that the "under the circumstances" portion of the general standard of care includes a time component - what might be considered ordinarily prudent in 1963 might not be considered so today.  As explained by Chancellor Allen of the Delaware Court of Chancery:

[100]  Can it be said today that, absent some ground giving rise to suspicion of violation of law, that corporate directors have no duty to assure that a corporate information gathering and reporting system exists which represents a good faith attempt to provide senior management and the Board with information respecting material acts, events or conditions within the corporation, including compliance with applicable statutes and regulations?  I certainly do not believe so…

[101]  [I]t would, in my opinion, be a mistake to conclude that our Supreme Court's statement in Graham concerning "espionage" means that corporate boards may satisfy their obligation to be reasonably informed concerning the corporation, without assuring themselves that information and reporting systems exist in the organisation that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation's compliance with law and its business performance."43

[102]  The judgment that caused the most concern with respect to the intensity of the director's duty of care in the United States remains the 1985 decision of the Delaware Court of Appeal in Smith v. Van Gorkom.44  In that case the board of directors approved a cash-out merger on very short notice, without having received any information or documentation in advance of the board meeting, on the basis of a presentation made at the meeting by the chief executive officer, and without obtaining any independent advice to support their business decision.  The court found the directors liable, inter alia, for having failed to act on a informed basis.
[103]  "The directors (1) did not adequately inform themselves as to Van Gorkom's role in forcing the "sale" of the Company and in establishing the per share purchase price; (2) were uniformed as to the intrinsic value of the Company; and (3) given the circumstances at a minimum, were grossly negligent in approving the "sale" of the Company upon two hours' consideration, without prior notice, and without the exigency of a crisis or emergency."45
[104]  The directors would most likely have escaped liability in the Van Gorkom case if they had insisted upon obtaining the advice of independent advisers, such as legal counsel or investment bankers in order to support their decision in relation to the price for which they recommended that shareholders dispose of their shares.

[105]  The law in the United States differs substantially on this point from the law in Canada.  Canadian directors are not quite under the same duty to enquire as their American counterparts.  American directors are similarly entitled to place reasonable reliance on management, but that reliance does not in any way substitute for their obligation to enquire.  Canadian directors, on the other hand, are entitled to rely on management in all cases, except only when circumstances have been brought to their attention that indicate that management is no longer worthy of that trust and reliance.

[106]  It is clear however, both in the United States and in Canada, that once the director has an obligation to enquire, the director is well advised to rely on persons with expertise in the matter that requires investigation.  In the United States reliance on experts does not constitute a defence for directors, it is merely an element to be considered in determining whether the directors have acted reasonably in fulfilling their duty of care.46   In Canada, on the other hand, we have seen that directors may invoke their reliance on experts as a statutory defence to liability.47  Once the directors become aware that a situation exists that indicates to them that management may no longer be relied upon, it will likely prove to be imprudent for a director to embark upon his or her own enquiry by examining the books and records of the corporation or by querying employees.  Any such forensic enquiry is bound to be fraught with considerable difficulty and potential pitfalls and is best left to expert advisers.

[107]  Given what we now know about the extent of the director's duty to inform herself in relation to the affairs of the corporation, it is now possible to answer the questions posed earlier48 as follows:

[112]  Opportunities Presented by Information Technology

[113]  We have seen that the use of information technology to improve the board process is not likely to have an adverse impact on the liability of directors.  But can it in fact improve the board process to a significant degree?

[114]  It is easy to assume that the use of computers and of information technology in business automatically makes an important contribution by permitting significant gains in quality and efficiency, particularly in leveraging the decision-making process.  Consider the following anecdote:

[115]  "From 1981 to the present, American businesses have spent hundreds of millions of dollars on software, to help in improving decision-making.  Software producers are now disbursing millions of dollars on research to make their programs even better and easier to use.  Spreadsheets and other decision-making aids are now ubiquitous, in academia and professions as well as in business.  Thus it is all the more remarkable how little research has been devoted to the effects of computers on the quality of decision-making.  Given more data and more powerful analytic tools, is it reasonable to assume that the quality of decisions will be correspondingly higher?  This may seem plausible, and possible.   It may even be true.  Yet only a handful of studies exist.  After all, why try to prove what everybody knows intuitively and what is built into the curriculum of business schools?  The problem is that there is growing evidence that software doesn't necessarily improve decision-making.

[116]  Jeffrey E. Kotteman, Fred D. Davis, and William E. Remus, specialists in business decisions, tested the ability of a group of students to control a simulated production line under conditions of demand with a strong random element.  They add more workers with the risk of idle time on one hand, or maintain a smaller workforce with the risk of higher overtime payments on the other.  They could restrict output relative to demand, possibly losing sales, if orders jumped, or they could maintain higher output at the cost of maintaining possibly excessive inventory.

[117]  The subjects, M.B.A. student volunteers and experienced spreadsheet users, were divided into two groups.  One group was shown a screen that prompted only for the number of units to produce and workforce level.  The other group could enter anticipated sales for each proposed set of choices and immediately run a simulation program to show the varying results for projected inventory.  They could immediately see the costs of changing workforce levels, along with overtime, idle time, and non-optimal inventory costs, all neatly displayed within seconds after entering their data.  They had no more real information than the first group, but a much more concrete idea of the consequences of every choice they made.

[118]  If all we have read about the power of spreadsheets is right, the "what-if" group should have outperformed the one with more limited information, unable to experiment with a wide variety of data.  Actually the what-if subjects incurred somewhat higher costs than those without the same analytical tools, although the difference between the two groups was, as expected, not statistically significant.  The most interesting results had less to do with actual performance than with the subjects' confidence.  The "non what-ifs" rated their own predictive ability fairly accurately.  The rating that subjects in the what-if group assigned to their own performance had no significant relationship to actual results.  The correlation was little better than if they had tossed coins.

[119]  Even more striking was how the subjects in the what-if group thought of the effects of the decision-making tools.  What-if analysis improved cost performance for only 58 percent of the subjects who used it, yet 87 percent of them thought it had helped them, five percent believed there was no difference, and only one percent thought that it had hurt.  This last-mentioned subject was actually one of those it had helped.  Another experiment had an even more disconcerting result: "decision-makers were indifferent between what-if analysis and a quantitative decision rule which, if used, would have led to tremendous cost savings."  In other words, the subjects preferred what-if exploration to a proven technique."49

[120]  This illustrates an application of the Pareto Principle, also known as the "80/20 principle".50
[121]  "The business world has long abided by the 80/20 rule.  It's especially true for software, where 80 percent of a product's uses take advantage of only 20 percent of its capabilities.  That means that most of us pay for what we don't want or need.  Software developers finally seem to understand this, and many are betting that modular applications will solve the problem."51
[122]  The computer assisted what-if analysis referred to above probably lies in the twenty percent zone of diminishing returns on the spectrum of applications of information technology in business.  The what-if algorithm is undoubtedly a complex process that sins by overestimating the power of computers, and underestimating the analytical capacity of the human brain.

[123]  There are simpler applications of technology that can yield large returns.

[124]  The board process yields its own examples of the Pareto Principle at work.  It is likely, for example, that, since each director on a typical board of directors has a unique background and skill set, and since the overall membership of the board of directors has been selected for the mix of skills that the directors bring to the board, each director will focus on a different aspect of the information that is made available to the board as a whole.  The 80/20 principle dictates that a relatively small percentage of the information supplied to the board as a whole will be of significant interest to any one director.  This means that the rate of relevance of the information package for each director will tend to be quite low.  Since each director will be likely to examine the information package from a distinctly different perspective, no two relevant slices of the total information package will be the same.  This in turn means that if one wanted to increase the absolute amount of relevant information for each director to a significant degree, one would have to increase the total volume of information by a very large factor indeed.

[125]  It is here that information technology does have an important role to play in increasing the efficiency of the board process.

[126]  "The tiny proportion of effort that uses the information revolution to create a different sort of corporation will have an explosive impact."52
[127]  Intranets excel at delivering information by exploiting the unique features of digital information.

[128]  As mentioned earlier in this paper,53 digital information is volume insensitive, format independent, and time and distance independent.  It is volume insensitive in that massive amounts of information can be stored very efficiently and be retrieved virtually instantaneously.  Digital information is format independent because binary computer files can store, transmit and display text, graphic, sound or video information in exactly the same way. Digital information is time independent because computers and computer networks are typically available twenty-four hours a day, seven days a week, all year long and the information travels very quickly. Finally, digital information is distant independent because of the extraordinary efficiency of distributed computer networks like the Internet.  The cost of accessing information from anywhere in the world is essentially flat.  The Louvre collection is just as easily available as the Smithsonian's or that of a local web site located on a computer just down the street, the cost is exactly the same in all cases, and is virtually nominal.

[129]  Once information exists in digital form, hypertext markup language can be used to create Web-based content, linking information in more than the simple, linear, two-dimensional way that paper-based information lends itself to.  Links are pervasive, and are the soul of a true Intranet.  Properly deployed, the Intranet links e-mail messages to Web content, and Intranet content to Internet content, providing an extremely powerful information management tool that is unprecedented.

[130]  Enlisted in aid of the board process, Intranet technology can speed the information preparation process and the information dissemination process by eliminating the inefficiency of paper,54  as well as allowing for far greater, deeper and richer collections of information to be placed at the disposal of directors than was the case in the past.

[131]  Thus, in addition to the pre-meeting information currently provided to directors, the Intranet makes it possible to provide industry analysis, company background information, corporate policies and operating procedures, continually up-to-date information on products and services, current and historical press releases and industry information, customer care information, information about employee resources and benefits, up-to-date management organisational structure, information on corporate structure and board memberships, historical records and archives of the board of directors, and much more.  In fact there is really no limit to the information that can be made available to directors.

[132]  In addition to the sheer quantity of information, links provide management with the ability to present layered information to directors, enabling directors to "drill down" through the information to levels of detail that in the past it would have been impossible to deliver.

[133]  The amalgam of these information management techniques amount to what is increasingly referred to as knowledge management.55

[134]  Implementation Issues

[135]  Implementing Intranet technology, though neither inherently complicated nor particularly costly, requires a thorough understanding of digital information and the strengths and limitations of humans and Internet Protocol information technology.  Seeking out the low-hanging fruit, and exploiting the power of the technology, can yield remarkable returns.  In the end, the key is to seek simplicity.

[136]  "The way to create something great is to create something simple.  Anyone who is serious about delivering better value to customers can easily do so, by reducing complexity."56

[137]  Conclusion

[138]  Internet Protocol information technology has the power to yield tremendous benefits in the realm of corporate governance, without exacerbating the risk of liability for directors.

[139]  End Notes

1.  Senior Legal Counsel and Assistant Corporate Secretary, Bell Canada and BCE Inc.  The views expressed in this paper are those of the author alone, and do not represent the views or policies of Bell Canada or BCE Inc.

2.  Sir Frederick Pollock and Frederic William Maitland, The History of English Law Before the Time of Edward I, Second edition, Cambridge University Press, 1968, pp. 486 and following, p. 687.

3.  This includes not only companies, but also partnerships, trusts, foundations, and other bodies governed by a committee.

4.  Charles Handy, The Hungry Spirit, Hutchison, London, 1997 at p. 176: "Consider these facts.  In a list of the world's hundred largest economies, fifty are corporations.  General Motors' sales revenues roughly equal the combined GNP of Tanzania, Ethiopia, Nepal, Bangladesh, Zaire, Uganda, Nigeria, Kenya and Pakistan.  In another list of the world's totalitarian and centrally-managed economies, Cuba comes in seventy-third place.  Seventy of the economies above her are corporations, as we have already noted.  Only China, whose rulers would like to think that they can manage centrally, gets into the top set.  North Korea doesn't even make the top 500."

5.  Bruce Welling, Corporate Law In Canada, Butterworths, Toronto, at pp. 328 and following.

6.  Shareholders, directors, officers, creditors, employees, and the state. See sections 238 and following of the Canada Business Corporations Act, R.S. 1985, c. C-44, as amended.  These provisions are of broad application and creditors (employees and the state are creditors) are among the classes of persons potentially protected from oppressive corporate actions.  See also Industry Canada, Discussion Paper on Directors' Liability, November 1995, Executive Summary on directors' liability.

7.  To borrow a civilian expression. Articles 2644 and following of Quebec's Civil Code re-iterate the rule that the property of a person is the common pledge of her creditors such that all of a person's property is charged with the performance of her obligations, with the usual exception of basic exemptions from seizure.  The consequence is that the property may be seized and sold to satisfy the claims of creditors.

8.  The Quebec Civil Code contains rules of general application that play a role similar to that of the common law and the rules of equity in common law jurisdictions.  See Maurice Martel and Paul Martel, La Compagnie au Québec - Les Aspects Juridiques, Wilson & Lafleur, Montréal, at pp. 23-1 and following.

9.  Report of the Standing Senate Committee on Banking, Trade and Commerce, the Kirby Report, named for the chairman, the Honourable Michael Kirby, August 1996, at p. 10.

10.  Industry Canada, Discussion Paper on Directors' Liability, November 1995, at paragraph 17.

11.  Report of the Toronto Stock Exchange Committee on Corporate Governance in Canada, Where Were the Directors?, December, 1994, p. 33, paragraph 5.53.

12.  Report of the Standing Senate Committee on Banking, Trade and Commerce, Op. cit. at pp. 12-13.

13.  Canada Business Corporations Act, R.S. 1985, c. C-44, as amended, s. 102. (1) "Subject to any unanimous shareholder agreement, the directors shall manage the business and affairs of a corporation."

14.  Ram Charan, Boards at Work, Jossey-Bass Publishers, San Francisco, 1998, chap. 5, What the Board Should Know, at p. 107.  David R. Leighton, Donald H Thain, Making Boards Work: What Directors Must Do to Make Canadian Boards Effective, McGraw-Hill Ryerson, 1997 at pp. 113 and following; Report of the Toronto Stock Exchange Committee on Corporate Governance in Canada, Where Were the Directors?, December, 1994, p. 17, section IV Board Responsibilities.

15.  Charan, Op. cit., at p. 54

16.  Leighton and Thain, Op. cit. At pp. 61 and following, Conflicts between theory and practice.  See also James A. Millard, The Responsible Director, Carswell Company Limited, 1989, at pp. 4 and following, Management of the Corporation.

17.  Canada Business Corporations Act, s. 18; Frank Iacobucci, Marilyn L. Pilkington and J. Robert S. Prichard, Canadian Business Corporations, Canada Law Book Limited, Agincourt, 1977, at pp. 104 and following; Welling, Op. cit., at pp. 188 and following.

18.  See note 13

19.  Vincent P. Barabba, Revisiting Plato's Cave - Business Design in an Age of Uncertainty, in Blueprint to the Digital Economy - Creating wealth in the era of e-business, Don Tapscott, Alex Lowy and David Ticoll, eds., McGraw-Hill, 1998, at p. 41.

20.  Leighton and Thain, Op. cit., at p. 250, Information Management.

21.  See note 6.  Directors will rarely receive direct information from shareholders, creditors and other stakeholders, but this type of information does in fact exist more than we might at first think.  Obvious examples are demand letters that are increasingly sent to directors as well as to management, and the questions posed by shareholders in the context of the corporation's annual general meeting.  In the case of Re Standard Trustco Limited et al (1992) 6 B.L.R. (2d) 241 (Ont. Sec. Comm.) the company's financial regulator presented its concerns directly to the directors.

22.  Charan, Op. cit. pp. 54, 55, 116; Leighton and Thain, Op. cit., p. 250.

23.  The duty to enquire is discussed in detail below.  Without regard to the duty to enquire, some observers point to the prudence of enquiring. James W. Dunphy, Directors in Distress, in Professional Administrator, Canadian Society of Corporate Secretaries, Vol. XXIII No. 2, at p. 2: "Ask for timely financial information..  If there is a loss, or a deterioration in workflow capital take active steps to ensure that statutory remittances are made on time.  Ask for a monthly report on remittances required and remittances made.  Document your involvement."

24.  Leighton and Thain, Op. cit. at p. 251 "In many companies, electronic networks are increasingly being used to provide more comprehensive and timely information.  With PC-based electronic mail and faxes, directors can readily receive a great deal of the information they need to do their jobs."

25.  R.S. 1985, c. C-44, as amended.

26.  Most notably in British Columbia, under the British Columbia Company Act, R.S.B.C. 1996, c. 62, and in Quebec under the Loi sur les Compagnies, L.R.Q., c. C-38.  Most jurisdictions have adopted reformed corporation statutes that frame the duties of directors substantially the same way as does the Canada Business Corporations Act.  The differences from jurisdiction to jurisdiction are sufficiently minor that the analysis in this paper may be considered to be applicable.  See Welling, Op. cit. at pp. 322 and following.

27.  [1925] 1 Ch. 407.

28.  [1925] 1 Ch. 407, at p. 428.

29.  [1899] 2 Ch. 629.

30.  [1899] 2 Ch. 629, at p. 673.

31.  McCarthy Tétreault, Directors and Officers' Duties and Liabilities, Butterworths, September 1997, at p. 17.

32.  See also Re Standard Trustco Limited et al (1992) 6 B.L.R. (2d) 241 (Ont. Sec. Comm.) where the regulator had advised directors that it had concerns about finances, at p. 285: "It was not appropriate in the circumstances for the respondent directors to have placed as much reliance on management as they did, both in terms of relying on management's financial statements and relying on management to consult with the outside lawyer and auditor.  Directors should not rely on management unquestioningly where they have reason to be concerned about the integrity or ability of management or where they have notice of a particular problem relating to management's activities."

33.  Bilotta v. Canada [1990] T.C.J. No. 1040 - Responsibility for failure to remit deductions at source - Director held liable for "turning a blind eye" to the corporation's affairs; Denis v. Canada [1989¨T.C.J. No. 834 - Responsibility for failure to remit deductions at source - The director, the mother of two sons who were also directors, could not close her eyes and rely on her sons; Starkman v. R. [1997] 2 C.T.C. 2040 - Responsibility for failure to remit deductions at source - Spouse turns a blind eye, relies on her husband, found liable.

34.  [1997] F.C.J. No. 881 (Fed. Ct. App.).

35.  [1995] 4 S.C.R. 5.

36.  [1995] 4 S.C.R. 5, at par. 64 and following.

37.  McCarthy Tétreault, Op. cit. at p. 19.

38.  For instance, under American rules, directors owe a fiduciary duty both the corporation they serve and to the corporation's shareholders, whereas in Canada the duty is only owed to the corporation. See Industry Canada, Discussion Paper on Directors' Liability, November 1995.

39.  [1925] 1 Ch. 407, at p. 428.

40.  McCarthy Tétreault, Op. cit. at p. 20.

41.  William E. Knepper and Dan A. Bailey, Liability of Corporate Officers and Directors, Lexis Law Publishing, at p. 47.

42.  Knepper and Bailey, Op. cit., at p. 79: The Revised Model Business Corporation Act provides: "A director shall discharge his duties as a director, including his duties as a member of a committee: (1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner he reasonably believes to be in the interests of the corporation."

43.  Pat K. Chew, Directors' and Officers' Liability, Practicing Law Institute, New York, 1998, Chapter 2 Making Business Decisions, at pp. 29 and following.

44.  488 A.2d 858 (Del. 1985).

45.  488 A.2d 858 (Del. 1985), at p. 874.

46.  Knepper and Bailey, Op. cit., at p. 89.

47.  Canada Business Corporations Act, s. 123 (4).

48.  See above at p. 8.

49.  Tenner, Edward, Why Things Bite Back - Technology and the Revenge of Unintended Consequences, Alfred A. Knopf, New York, N.Y., 1996, p.  204, ff.

50.  Richard Koch, The 80/20 Principle - The Secret of Achieving More with Less, 1st Currency edition, Doubleday, 1998.

51.  Quoted from an article entitled Software Developers create modular applications that include low prices and core functions in the January 17, 1994 issue of MacWeek, by Koch, Op. cit., at p. 48

52.  Richard Koch, Op. cit., at p. 50.

53.  See page 8 above.

54.  The preparation of paper-based pre-meeting materials is a very time-consuming process.   Delivery by messenger is generally overnight, sometimes longer.  Even faxing information is relatively inefficient.  For instance, if there are 15 directors on a Board of Directors and it is necessary to send a 20 page facsimile transmission to each one, the overall transmission time will be approximately three hours and forty-five minutes, assuming that there are no interruptions attributable to equipment problems and no down time between transmissions.

55.  Knowledge management refers the use of computerised indexation, analysis and collaboration tools used against large, distributed repositories of information residing on enterprise networks.  See J. Bruce Harreld, Building Smarter, Faster Organisations, Tapscott, Lowy and Ticoll, Op. cit. at p. 61.

56.  Koch, Op. cit., at p. 99.

© David Masse - October 1999