Last year was a difficult one for many corporations, and even bullish forecasts for the balance of this year indicate further challenges ahead. Sovereign debt risk in the Eurozone, slowing growth in China and continuing problems for our neighbour to the south present challenges (and opportunities) for Canadian businesses. Many businesses are experiencing liquidity and solvency issues and many more will in these uncertain economic times. Against this backdrop, directors and officers need to be more vigilant and pay closer attention to the liquidity and solvency of their corporation.
It is important that directors and officers have a clear understanding of their duties to ensure that they are not exposing themselves to undue levels of personal liability. A clear understanding will ensure that directors and officers, who are responsible for the affairs of the corporation, are able to accurately assess their potential for personal liability.
Directors and officers are required, under corporate law statutes, to act honestly, in good faith and with a view to the best interests of the corporation and exercise the care, diligence and skill of a reasonably prudent person. These two broad general responsibilities, more commonly known as the fiduciary duty and the duty of care, impose obligations on directors and officers to be diligent in supervising and managing the affairs of the corporation and avoid conflicts of interest with the corporation. Directors and officers should appreciate these duties are paramount as breaches of these duties may, in certain circumstances, give rise to personal liability.
Most directors and officers are aware of these corporate law duties and the real risk of personal liability for breaches of them. However, many directors and officers may not be aware that they can also be held personally liable under a wide array of provincial, territorial and federal statutes. Many tax, employment, pension, employment insurance and bankruptcy law statutes also impose personal liability upon directors and officers. The requirements under these statutes and the personal liability that attaches for breaches of those requirements are in addition to the duties directors and officers owe to the corporation under corporate law statutes.
As corporations experience deteriorating financial conditions, directors and officers should exercise an additional level of due diligence to ensure that their corporations are keeping up with their obligations to remit, withhold or deduct certain amounts from employees wages, Canada Pension Plan contributions, social services tax, income tax and goods and services tax. Directors and officers should ensure that their corporation has met and continues to meet its ongoing obligation in respect of its remittances. If a director or officer has become aware of a failure to deduct, withhold or remit statutory amounts, they should act positively and make sure that all reasonable efforts are taken to remedy the situation. If the corporation fails to meet their statutory duties to remit taxes, directors and officers may be held jointly and severally liable, together with the corporation to pay that amount and any related interest or penalties.
The primary way corporations have insulated directors and officers from their statutory liabilities is through director and officer (D&O) liability insurance coverage. D&O insurance is typically purchased by corporations to insure their directors, officers, managers and executives from claims brought against them by shareholders, employees, clients, creditors and government regulators. However, all D&O insurance is not created equal and the level of coverage for directors and officers varies greatly from policy to policy.
Directors and officers should regularly review their D&O insurance policies to ensure that it affords adequate coverage and terms. As a corporation approaches insolvency, directors and officers should carefully review their D&O insurance policies and consider the adequacy of the coverage in the context of an insolvency proceeding. In some circumstances, it may be necessary for directors and officers to purchase additional insurance to provide appropriate coverage in insolvency situations. Whenever directors or officers are aware that insolvency is on the horizon, they should have their D&O insurance policies reviewed by legal counsel familiar with insolvency issues.
Aside from D&O insurance, directors and officers can protect themselves from much of the personal liability imposed by federal and provincial statutes when they act in a pro-active and diligent manner. By taking steps to ensure that corporate debts, for which personal liability attaches by statute, are paid in a timely manner, directors and officers can often eliminate the debt that is the source of the personal liability before insolvency and provide themselves with a due diligence defence to other potential claims. Directors and officers should also ensure that any actions taken are recorded carefully, with reasons for the decisions if considered appropriate as a paper trail will become crucial if the corporation becomes insolvent and the directors and officers are called upon to defend their actions.
Directors and officers need to devote more time and attention to the corporation’s affairs and financial stability in the zone of insolvency than is required when the corporation is financially healthy. Process protections and D&O insurance are integral components for directors and officers of corporations to manage their risk exposure to personal liability. However, directors and officers that exercise the care of a reasonably prudent person, due diligence and reasonable reliance on the advice of legal and financial experts will be able to provide themselves with best defence against the personal liability imposed in the provisions of many corporate tax, employment, pension, employment insurance and bankruptcy law statutes.
These uncertain economic times should serve as a useful reminder to directors and officers to keep a close eye on the financial position of the corporation they run and ensure that they are mindful of the substantial duties they owe to it. If directors or officers have any concerns as to those duties, they should seek external counsel from both financial and legal advisors. Financial and legal advisors can assist directors and officers in taking into account all of the factors enumerated by the business judgment rule for making informed decisions.
This article briefly discusses the exposure of directors and officers of a corporation to potential personal liability and some of the ways in which directors and officers can limit their exposure amidst the current economic climate. For a more in-depth analysis of this article, please view our paper on Director and Officer Liability in Insolvent Circumstances (PDF). If you have any questions or concerns regarding your exposure to personal liability as a director or officer of a corporation or if your corporation is experiencing financial difficulties, contact Aaron Singer at 604.643.3108 or firstname.lastname@example.org.