It is common for shareholders of both public and private companies to
nominate directors to sit on the companies' boards on their behalf. This commonly occurs when an investor is an
institution, when it has the contractual rights to control one or more board
seats, or when an investor wishes to appoint an employee or an individual with
particular experience to the board.
These "nominee directors",
however, often find themselves conflicted. While the nominating shareholder
will naturally expect its nominee director to demonstrate loyalty and advocate
on the shareholder's behalf, the nominee director owes specific legal duties to
the corporation that are founded upon good faith, candor, confidentiality and
the best interests of the corporation.
This paper examines these
responsibilities, particularly as they apply to nominee directors on the boards
of Canadian companies, and how these directors can protect themselves from
conflict situations.
DIRECTORS' DUTIES: CANADA VS. THE U.S.
For starters, certain distinctions must
be made between the duties of the boards of directors for Canadian and American
companies. In the U.S., while the obligation is officially owed to the
corporation, in a sale context that duty shifts to maximizing shareholder
value. As the Delaware Supreme Court made clear inRevlon Inc v MacAndrews
& Forbes Holdings, 506 A (2d) 173 (1986), a board's decision on the
sale of a corporation is governed by the duty to obtain the highest value
reasonably available to shareholders. This has become known as the "Revlon
duty." Once a board decides to sell the company, or a sale of the company
is inevitable, the directors essentially act as auctioneers.
On the other hand, Canadian company
board members must act honestly and in good faith with a view to the best
interests of the corporation itself, including in a sale process. This duty is
owed to the corporation and all its "stakeholders"--this includes
shareholders, but the financial interests of shareholders are not necessarily
paramount.
In BCE Inc. v. 1976
Debentureholders 2008 SCC 69 ("BCE") the Supreme Court of
Canada (SCC) considered, among other corporate law concepts, the duty of
loyalty. The SCC affirmed that directors of a Canadian corporation may consider
the interests of a variety of stakeholders-- including shareholders, employees,
creditors, consumers, governments and even the environment--to inform their
decisions. The Supreme Court clarified that, unlike the predominant view in the
U.S., there is no Canadian principle that allows one type of stakeholders'
interests (for example, the interests of shareholders) to automatically prevail
over all other interests. Instead, what the directors deem to be in the
corporation's best interests in any particular situation is a matter of
business judgment.
By deferring to the business acumen of a
corporate board, Canadian courts rely on a well-entrenched principle of Canadian
corporate law known as the business judgment rule (BJR). The BJR requires a
court to show appropriate deference to a good faith decision by directors,
provided that the decision is reached on an informed basis and is within a
"range of reasonableness." As such, directors should not be faulted
for simple errors of business judgment. In the absence of evidence to the
contrary, it can be presumed that a corporation's directors are acting on an
informed basis in good faith and with the corporation's best interests in mind.
Decisions made by a Canadian board of
directors are generally immune from judicial review where:
1.
The directors informed themselves (e.g.,
made reasonable inquiries) on which they could form a business judgment before
making their decision.
2.
They acted in good faith, in accordance
with law and their fiduciary duties.
3.
Their decision appeared to have a
rational basis when it was made. (It is worth noting that it need not have been
the most rational.)
Additionally, the court in BCE noted
that, where the corporation is a going concern, directors should consider the
corporation's long-term interests in exercising their duties.
A NOMINEE DIRECTOR'S DUTY
The fiduciary duty owed by a
corporation's directors extends uniformly to nominee directors; as a matter of
law, a nominee director is not simply an agent of his or her appointing
shareholder (no matter how much the nominating shareholder would like that to
be the case). Rather, a nominee director is an overseer required by law to
supervise the corporation's business and affairs, and whose duties are owed to
the corporation itself as opposed to the appointing shareholder (or
shareholders). These legal principles may conflict with commercial realities,
but in Canada, the law is clear.
Canadian courts have generally found
that nominee directors may be in breach of their fiduciary duty to the
corporation where they:
- Fail to
maintain an even hand.
- Fail to
analyze a course of action from the corporation's perspective.
- Fail to
disclose to the corporation information that impacts the business of the
corporation.
The duties of a director to the
corporation are not diminished by virtue of having been nominated by a
shareholder, and, therefore, should the interests of the appointing shareholder
differ from the corporation's, the nominee director must proceed cautiously and
in the sole interest of the corporation entrusted to his or her care. As
discussed below, it may be appropriate for a nominee director to recuse him or
herself from transactions or contracts that could give rise to an actual or
potential conflict.
CONFLICTS OF INTEREST
There are certain situations where
nominee directors have specific rights and responsibilities, and they must
remain aware of them in order to avoid breaching their duties.
The first is where a conflict of
interest arises between the nominating shareholder and the corporation. In such
an instance, the director has a statutory duty to disclose his or her interest
(be it in a proposed transaction or contract) when the director first becomes
interested. The director must make this disclosure in writing or at a board
meeting and request that his or her interest be entered into the minutes of the
meeting. While the level of detail required will depend upon the circumstances,
the disclosure must explain both the nature and extent of the director's
interest and enable the remaining directors to make an informed judgment and
properly assess the interests of the corporation on the basis of the declared
relationship.
For nominee directors of a public
corporation, additional considerations arise as a result of securities law
requirements. Canadian securities laws require directors engaged in an insider
bid or related-party transaction to make certain disclosures to shareholders.
The board must, for instance, disclose the circumstances of its approval
process, including the establishment of a special committee of directors, if
applicable, along with any contrary views of directors on the proposed
transaction.
Concerns about conflicts of interest may
make it prudent for directors to recuse themselves from board discussions in
some circumstances. In a change-of-control scenario, for example, if a
nominating investor has a unique or special interest in the transaction, the board
may determine that the nominee shareholder should not participate in
discussions or vote on the transaction.
CONFIDENTIALITY
In addition to the duty to avoid
conflict of interest, directors of Canadian companies have a duty to the
company to maintain confidentiality. If a nominee director becomes aware of
significant information at a board meeting, for example, he or she may not
necessarily be able to immediately share this information with his or her
appointing shareholder.
In a private company with only a few
large shareholders, this may not be a practical concern. It can become an
issue, however, when a private company is widely-held and has many smaller
shareholders or the company is publicly listed.
Nominee directors of public companies
must also take care not to fall offside insider trading prohibitions on
"tipping" by disclosing non-public information to an investor. Under
Canadian securities laws, it is an offense for an appointing shareholder to
purchase or sell an issuer's securities with knowledge of material information
that has not been generally disclosed. Likewise, it is an offense for a nominee
director to inform, outside of the necessary course of business, his or her
appointing shareholder of a material fact or change in respect of the issuer
before that fact or change has been generally disclosed.
Should a nominating shareholder receive
non-public information from its nominee director, the shareholder should make
sure that there are sufficient safeguards in place, such as a "restricted
list" to ensure no trades are made. If the shareholder trades in these
securities for unrelated reasons (for example, where the investor is a
financial institution with various divisions), it should establish a wall
between the nominee director and the trading division to ensure no material
undisclosed information is transmitted.
STRATEGIES FOR AVOIDING A BREACH OF DUTY
Shareholders and nominees alike should
consider a number of strategies for ensuring the director is able to fulfill
his or her duties properly and free from conflict.
Under Canadian law, a director cannot
"waive" fiduciary duties (or have them waived by the corporation).
However, in the private company context, it is possible for the shareholders to
adopt a unanimous shareholders agreement ("USA"), whereby the powers
and duties of the directors are taken away and vested instead in the
shareholders themselves. This effectively relieves the directors from potential
liability, but also takes away their powers--in many ways, this structure is
akin to a membermanaged Delaware LLC.
Subject to a USA, no provision in a
contract, article, bylaw or resolution can relieve a director from his or her
duty to act in accordance with Canadian corporate law statutes-- or from
liability for breaching that duty.
Clear, current and enforced board
policies that address sharing information with shareholders, insider trading
and corporate opportunities, will help mitigate risk by clarifying directors'
responsibilities with respect to confidentiality and conflict of interest.
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