Protecting Directors Against Liability

Actions against directors of public and private companies can come from several sources, including:
a.. shareholders,
b.. employees, and
c.. third parties such as creditors, governmental agencies and consumer groups.

Given the breadth of possible liability, protecting individuals against adverse financial consequences of serving as directors is important. Directors are liable for up to two months unpaid wages for each employee, the amount of remittances required to be paid by the company under the Income Tax Act and damages suffered by a person who relies upon a misrepresentation in a filed prospectus. Directors are also liable for loss or damage suffered by the company as a result of a resolution voted for by the directors for the purchase of shares in the company or for the payment of dividends when the company is insolvent. In addition, many statutes impose penalties on directors. Directors (including officers, former directors and officers and their respective heirs) are by law entitled to be indemnified against liabilities properly incurred by them in managing the company. This right does not extend to wrongful acts or acts done beyond the authority of the director.

A wrongful act is best defined as an act which does not meet the tests set out in the legislation which governs the company. In a criminal or administrative case that results in a monetary penalty, directors and officers, to be indemnified, must also establish that they had reasonable grounds for believing their conduct was lawful.

The Canada Business Corporations Act says directors are entitled to indemnity for the costs of defending themselves if their defence is substantially successful, and they meet the tests referred to earlier.

A corporation incorporated under the Canada Business Corporations Act does not need court approval to indemnify its directors, unless the claim against them is made by the corporation itself, or a director applies for court approval. If the claim is made by the corporation, the court’s power is limited. It can approve an indemnity for the directors’ costs of defending the claim, but not for the actual amount of any settlement or judgment against directors.

Directors and officers should have legal advice regarding indemnification. Companies should consider whether insurance should be obtained for directors and officers, who may also consider obtaining their own Directors’ and Officers’ insurance. Directors and officers should also obtain legal advice regarding difficult judgments they are required to make in the course of conducting the affairs of the company. If legal advice is sought and prudently followed, directors and officers may more easily show they have met the legal tests which qualify them for indemnification.

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