Corporations - Directors Duties

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Client Letter - What this idea is about

This entire site is for educational or informational purposes only. You are not to use the forms, concepts, strategies, or knowledge without assistance from a professional. The author, the corporation, the ISP, Bob Parrish CPA, Bob Parrish CPA, P.C. or other parties related to those or this site do not guarantee or warrantee in any manner the suitability, usefulness, accuracy, timeliness, or results of any portions of this site, nor the links contained in this site which link to other areas. At times, information is taken from other sources and is believed to be accurate, but no verification or confirmation is performed. Furthermore, if any federal or state law invalidates a portion of this disclaimer, the other portions still apply. In addition, any allegations or actions are restricted to arbitration only and must be arbitrated by the Better Business Bureau in Sarasota Florida. Reading of these pages constitutes complete acceptance and agreement with all disclaimer provisions on all pages of this site. .......

Learning Objectives

What it does, Why it works - Plain English Analysis

This part of the guide sets out the function and mandate of the board of directors. It describes the fundamental corporate and common law duties of a director and the general standards applicable to the discharge of those duties. Finally, it identifies the remedies available to shareholders, creditors and others to ensure that directors discharge their responsibilities in the manner prescribed by law.

(a) Frequency
The frequency with which a board meets will vary from one corporation to the next. It will also depend, in part, on the particular corporate activities requiring specific board attention and on the number of matters that are dealt with primarily by committees of the board as opposed to the full board. Most companies schedule their full board meetings at regular intervals, such as each quarter, often coinciding with the need to deal with matters such as quarterly financial information and dividends. If a corporation is involved in a major restructuring, financing or acquisition, it may be necessary for the board and perhaps one or more of its committees to meet more frequently to consider and approve a particular course of action. The various committees meet around these general board meetings as required to satisfy their particular committee mandates.
Regular meetings of a board are often half-day or daylong events. If a meeting has been called for a specific purpose, it may be quite brief or it may last significantly longer than a regular meeting.
(b) Notice of Meeting, Attendance and Written Resolutions
All directors are entitled to receive notice of all meetings of the board and no director may be excluded from such meetings. Except for certain matters specified by the corporate statutes and subject to the corporation's by-laws, there is no general technical requirement to specify in notices the matters that will be discussed at the meeting. However, as a practical matter, notices do specify such matters and include considerable detail and background. Unless notice is given in accordance with the corporation's by-laws or statutory requirements, the board meeting is not duly constituted and the business conducted at that meeting is of no effect. For this reason, where a board meeting must be called quickly and there is not sufficient time to give the required notice, the corporation may ask directors who were not present at the meeting to sign a waiver of notice. A director's presence at the meeting constitutes waiver of the notice requirements.
Attendance at board meetings is central to the discharge of a director's responsibilities. Dates of meetings of the board are normally set well in advance, in order to allow directors to schedule all their affairs. Unless directors attend meetings, participate in discussions with other members of the board and question management, they are unlikely to be fully informed about the affairs of the corporation and cannot expect to be in a position to meet the standard of care and diligence imposed on them. In some jurisdictions, the corporation is required to disclose in the proxy materials how many meetings each director attended.
Directors should also bear in mind that they will be deemed to have consented to any board resolution passed in their absence unless they dissent in the manner prescribed by statute (described under "Voting" below), and that they will be liable along with all the other directors who did not dissent for the acts and omissions of the board.

What It does, Why it works - Technical Analysis & Citations

Tax Killers

This is about Activity Based Taxplanning - maximizing deductions, minimizing cash outlay and maximizing the amount of cash retained and the net worth.

Tax is a subject that many view in order to cut costs. Taxes are a cost just as any other cost. It happens this cost is somewhat intangible and is defined by legislation without a tangible item to view and control. The money is spent and the control of the expenditure is more appropriately administered by someone trained in the law.

Cost Killers

This is about Activity Based Costing - methods to cut costs, management accounting, management information systems, decision support systems - in general about being a manager.

What to gather - preparing for your CPA, your attorney, or preparing to start the job on your own

Assistance - What To Do - Forms - checklists, time-line to do, etc.

Spreadsheets & Computations

Contracts, Trusts, etc.

Reports Required

Checklists for Deployment

Checklist for Monitoring

Financial Accounting: Bookkeeping & Financials

Compliance - what is required for protection, defense, etc.

Alerts & Dangers - Risks, Asset Protection, IRS Defense

INTRODUCTION

DUTIES OF DIRECTORS

Function of the Board of Directors
Manage versus Monitor
Mandate of the Board

Standards of Performance
Fiduciary Duty
Care, Diligence and Skill
Business Judgment

To Whom are Directors Accountable?
Interests of the Shareholders
Interests of Other Stakeholders

Reliance on Management, Financial Statements and Advisors
Reliance on Management
Reliance on Financial Statements
Reliance on Advisors

Taking Action Against the Directors
Oppression
Derivative Action
Compliance Orders

CORPORATE GOVERNANCE

Membership of the Board
Number of Directors
The Independent Director
Chair
Qualification
Election and Term
Remuneration
Vacancies
Resignation and Removal

Board Meetings
Frequency
Notice of Meeting, Attendance and Written Resolutions
Location and Telephone Meetings
Quorum
Voting
Minutes

Delegation
Board Committees
Audit Committee
Special Committees

Directors' Conflict of Interest
When Does a Conflict Arise?
Voting and Abstaining from Voting

Confidential Information
Corporate Opportunity
Duty of Confidence and Insider Trading

Information Management
Information Provided to Directors
Financial Statements
Timely Disclosure

Securities and Stock Exchange Requirements
Role of the Securities Regulator
Stock Exchanges

The Role of Shareholders
Shareholder Meetings
Shareholder Ability to Change the Board
Dissent Rights

DIRECTORS IN ACTION

Financing
Issuing Debt
Issuing Shares
(i) Purpose and Consideration
(ii) Shareholder Approval Required
Accessing the Capital Markets
(i) Private Placements
(ii) Public Capital
(iii) Proceeding with a Public Financing -
The Long Form Prospectus
(iv) Proceeding with a Public Financing -
The Short Form Prospectus
Dividends
(i) Discretion to Declare Dividends
(ii) Declaring the Dividend

Disclosure Obligations
Timely Disclosure
Announcing a Transaction
Financial Statements
Annual Information Form ("AIF")
Management Discussion and Analysis ("MD&A")
Executive Compensation
Proxy Rules
Insider Reporting and Trading

Dealing With a Controlling Shareholder
Ongoing Relationship with the Controlling Shareholder
Transactions Between the Corporation and the
Controlling Shareholder

Significant Transactions
Take-over Bids
Other Significant Transactions

Environmental Matters
Ongoing Compliance
Specific Occurrences
Acquiring an Interest in Real Estate

Facing Insolvency
The Role of the Board
To Whom Directors Owe Their Duty
Personal Liability

Derivative Products
Overview
What is a Derivative Product?
Issues for Corporate Directors
What Should Corporate Directors Do?

STATUTORY LIABILITIES

Impairment of Capital and Corporate Solvency Tests
Types of Payment
Corporate Solvency Tests
Defence and Penalty

Insider Trading
Directors as Insiders
Insider Trading Reports
Use of Inside Information
Defences
When is Information Disclosed

Disclosure Documents
Ongoing Disclosure Documents
Prospectuses

Liability for Offences Under the Corporate Statutes

Environmental Legislation
Offences
Due Diligence Defence
Penalties

Pension Matters

Tax Liabilities
Source Deductions and Other Remittances
Offences of the Corporation
Clearance Certificates
GST
Other Tax Statutes

MANAGING THE RISK

Limiting the Risk
Discharge of Responsibilities
Unanimous Shareholder Agreements
Trust Accounts and Letters of Credit
Resignation

Indemnities
Limitations
Tax Treatment
Mandatory Indemnity
Indemnities Contained in By-laws
Contractual Indemnities

Insurance
Acquiring Insurance
Terms of the Policy

When an Action is Brought

CONCLUSION

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INTRODUCTION
D irectors of corporations have good reason to be concerned about their responsibilities and potential liabilities. Society has become increasingly interested in corporate accountability and, in particular, the accountability of individuals who direct corporate behaviour. Demands for accountability have heightened in the last 10 years as banks and insurance companies in Canada and savings and loan corporations in the United States have failed, as the after-effects of highly leveraged take-overs have taken their toll, as consumer protectionism and environmental awareness have increased and as the recession has had an impact on businesses of every size. As a result, courts, regulators, legislators and shareholders are scrutinizing more closely the way in which directors discharge their responsibilities. In addition, legislators and courts have further increased the pressure on directors by making them subject to personal liability if the corporation breaches certain statutory requirements which promote certain social goals.

Directors are responding by monitoring more closely the activities of the corporations they serve and by evaluating more critically their exposure to liability as a result of the corporation's activities and financial condition. Directors are recognizing that, in order to discharge their duties with the necessary degree of care, they need to catalogue these responsibilities and the risk of liability associated with them. Directors are also recognizing that in many cases the risk can be managed if they understand fully the nature of their obligations.

This guide outlines certain of the responsibilities and liabilities imposed on directors of Canadian corporations. While the focus will be on public companies, private company directors have the same responsibilities and liabilities as their public company counterparts, other than those imposed by securities laws or stock exchange requirements. The difference between the two is usually found in the degree of public scrutiny of the directors' actions.

€ Part I sets out certain of the corporate and common law duties of directors and describes the general principles applicable to the discharge of those duties. It also outlines the manner in which the corporation, shareholders and third parties may enforce those duties.

€ Part II addresses corporate governance as it relates to the process by which boards of directors discharge their responsibilities.

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€ Part III discusses a number of decisions which directors typically face and highlights the issues which should be of particular concern to a director making such decisions.

€ Part IV describes some of the additional statutory duties imposed on directors, the penalties associated with a breach of those duties and the defences available.

€ Part V reviews the ways directors can protect themselves from liability, in particular through indemnities and insurance.

Reference will be primarily to corporations governed by the Canada Business Corporations Act (the "CBCA") and the duties and liabilities imposed on directors of those corporations. While many of the provincial corporations acts are substantially similar to the CBCA, there are certain differences from one statute to the next in the provisions dealing with directors. Certain of the significant differences have been highlighted, but directors should consult counsel to ensure that they are aware of all of the responsibilities imposed on them by their corporation's governing statute. Corporations which carry on business in certain regulated industries such as banking are not subject to these corporate statutes. However, the governing statutes of many of these corporations impose the same broad duties on directors as do the corporate statutes, in addition to certain additional responsibilities relevant to the particular industry in question. These industry-specific responsibilities are referred to occasionally, but are not treated exhaustively. Again, boards of directors should consult their legal advisors for advice on liabilities peculiar to their industry.

Reference is also made to the Guidelines for improved corporate governance contained in the final report of The Toronto Stock Exchange Committee on Corporate Governance in Canada (the "TSE Corporate Governance Committee") issued in December 1994 (the"TSE Report"). These Guidelines are designed to provide corporations with benchmarks for evaluating their own systems of corporate governance in such areas as the composition of the board of directors, the responsibilities of the board, board committees and individual directors, as well as the board's relationships with management, shareholders and controlling shareholders.

Finally, this guide identifies only a sampling of the more significant statutory duties imposed on directors. Directors must ensure that they are fully informed of all their responsibilities and potential liabilities in order to meet the standards imposed on them by law.

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I. DUTIES OF DIRECTORS A director's duty is owed first and foremost to the corporation. This duty is grounded in basic principles of good faith, stewardship and accountability. Requirements imposed both by the common law and various statutes seek to establish the parameters of this duty, without limiting the flexibility of these principles.

1. Function of the Board of Directors
The directors' role is one of stewardship. Directors are responsible for managing or, under some statutes, supervising the management of, the corporation. Shareholders make a financial investment in the corporation which entitles those with voting shares to elect the directors. If shareholders are not satisfied with the performance of the directors, they may remove the directors or refuse to re-elect them. Except for certain fundamental transactions or changes, shareholders normally do not participate directly in corporate decision-making and while, as a practical matter, boards want to know the views of the shareholders, strictly speaking, directors are not normally required to solicit or comply with the wishes of shareholders.

Directors have complete discretion to exercise their powers as they deem appropriate, subject to the constraints imposed by law. Each director must act honestly and in good faith with a view to the best interests of the corporation and must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. Delegation is permitted with certain exceptions and must be reasonable in the circumstances, but responsibility for major decisions and the exercise of general discretion will always be the responsibility of the directors.

(a) Manage versus Monitor
The complexities of modern business impose a number of constraints on the ability of directors to manage or even to supervise the management of a corporation. Most directors do not have sufficient expertise in all aspects of the corporation's business to be able to make many business decisions. In addition, directors generally do not have access to, control over or time to absorb all the information needed to manage the business. These constraints shape the role of the board of directors.

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The TSE Corporate Governance Committee recognized that a board may supervise, direct or oversee the business and affairs of a corporation, but cannot manage them, at least not in a day-to-day sense. This kind of management must be delegated to others.
Directors are not required to devote their full time and attention to the corporation's affairs. Rather, they perform their functions periodically, primarily in preparing for and attending meetings of the board of directors, and are usually not involved in the day-to-day operations of the business. While directors provide general direction to the corporation, for example, in respect of new markets or products or significant financing activities, they must delegate much of the responsibility for managing the affairs of the corporation to others. In most respects then, directors monitor rather than actively manage the corporation's business and affairs.
Responsibility for the day-to-day management of a corporation's affairs is delegated to the chief executive officer, chief operating officer and other senior executives who are responsible to, and report back to the board from time to time. Appointing these senior executives and evaluating their performance are among the most important functions of the board. The relationship between the board and senior management � some of whom typically also sit on the board � is critical to good corporate governance and to minimizing the risk of liability to directors. The board must have confidence in the abilities, judgment and integrity of the corporation's senior executives. Communication and candour between the board and management are critical if the board is to be confident that it is being kept fully abreast of issues and developments facing the corporation.
Notwithstanding the delegation to senior executives of very broad powers over a corporation's affairs, the board of directors must reserve to itself the ability to intervene in management's decisions and to exercise final judgment on any matter which is material to the corporation. Although there is no bright line separating the duties of the board from the duties of senior management, the overriding principle governing delegation is that the directors must retain ultimate control over the corporation. The directors must be sufficiently familiar with the business and affairs of the corporation to know that the corporation is being managed in an appropriate fashion. They must exercise sufficient leadership to ensure that the corporation is following a course which they have approved. Whether business decisions actually originate with the directors is less central to the board's function than whether the directors are monitoring how these decisions are formulated and implemented.
The image of the corporate director as a figurehead is not now, if it ever was, accurate. The old perceptions of directors as passive observers of the corporate process no longer apply. Directors are now more visible and assertive. While the day-to-day management of the corporation remains in the hands of senior management as a matter of practical necessity, the monitoring role of the board must be a proactive and effective one if the directors are to carry out their duties properly and avoid liability.
(b) Mandate of the Board
The mandate of the board will vary from corporation to corporation. The corporate statutes allow some flexibility in the way each corporation is governed to allow the parties involved to tailor the allocation of responsibility for running the corporation among shareholders, directors and management to suit particular needs and circumstances.
The board performs certain functions prescribed by statute and is normally involved in considering significant issues facing the corporation. For the most part, management determines what matters are put before the board. To a lesser extent, the directors themselves make this determination through standing resolutions, guidelines or by-laws initiated by the directors.

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Among the matters generally put before boards are financial statements, business plans, major capital expenditures, raising capital and other major financial activities, executive hiring, compensation, assessment and succession, issues relating to the corporation's products or services (such as quality and safety), decisions to devote resources to new lines of business, organizational restructurings and acquisitions and divestitures.
In order for a board of directors to discharge its responsibilities, it must not only be aware of and approve the general direction and plans of the corporation, it must also be satisfied that the plans which it has approved are being implemented consistently and that appropriate monitoring and audit systems are in place to ensure that the corporation's affairs are being run responsibly. This is done in part by the process of reviewing and approving materials such as budgets, operating plans and strategic plans and by seeking and relying on the advice of experts, both from within the ranks of the corporation's management and from outside the corporation.
Increasingly, boards are adopting comprehensive audits of particular aspects of corporate operations as an integral part of effective monitoring. Boards have always used audits in the accounting context, but now they are expanding their use in other areas. For example, environmental audits are common, and audits of sales and pricing policies are becoming increasingly common to ensure compliance with competition laws as are audits of purchasing procedures to confirm the integrity of tender processes.
Implementing appropriate audit procedures is important, even if there is no particular area of concern, because such procedures allow the board to satisfy itself about the day-to-day operations of the corporation's business and other aspects of management's activities which the board itself cannot realistically expect to oversee or review. The board usually receives audit results from outside experts or advisors who performed the audit and who are in a position to explain the results and their implications to the directors. In addition to being an effective and necessary part of the monitoring process, these procedures will in many cases be key in assisting directors to defend themselves against claims if it is alleged that they have fallen short of their legal obligations in discharging their duties.
The TSE Corporate Governance Committee, in discussing the issue of the mandate of the board, suggests that effective corporate governance requires every board of directors to assume responsibility for the stewardship of the corporation. As part of this overall stewardship responsibility, the TSE Report recommends that a board should explicitly assume specific responsibility for the following matters:
€ adoption of a strategic planning process;
€ identification of the principal risks of the corporation's business and insuring the implementation of appropriate systems to manage those risks;
€ succession planning, including appointing, training and monitoring senior management;
€ a communications policy for the corporation; and
€ the integrity of the corporation's internal control and management information systems.
The manner in which a board of directors carries out its mandate depends on the particular corporation, its business, size and geographic scope and the nature of delegation to management. In some corporations, directors may be involved in making major business decisions, while in others decision-making may be more decentralized. In some cases, directors may be expected to craft the corporation's long-term strategic plan, while in others this may initially be the responsibility of a sophisticated strategic planning department. Increasingly, boards are establishing committees of the board to assist in carrying out their role and responsibilities.

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Part of the directors' contribution is the unique perspective they bring to corporate management. This applies in particular to outside directors. It may be difficult, for example, for management to take a long-term view of the corporation's business, in particular where remuneration is tied to short-term performance. Some investors, too, tend to have a short-term orientation, and the price of a corporation's securities is, therefore, driven to some extent by short-term rather than long-term results. Directors may be able to provide a tempering influence by introducing a longer-term perspective into the corporation's actions.
The dynamics of the board may depend on the extent to which specific shareholder interests are represented on the board. In Canada, to a considerably higher degree than in the United States, large corporations tend to have a controlling shareholder. The shareholder will generally determine who sits on the board and may advise the directors on the action it wishes the corporation to take. Frequently, directors will be able to reconcile the interests of the controlling shareholder with their fiduciary duties and the right of the minority to be treated fairly. In some cases, where a corporation is a wholly-owned subsidiary of another, either the interests of the subsidiary will be identical to those of its corporate shareholder or there may be no other party whose interests could be prejudiced by the action which the shareholder wishes the subsidiary to take. Directors should, in any case, be aware that the law charges them with the same responsibilities and subjects them to the same liabilities, whether the corporation they serve is closely controlled or widely held.
The objectivity which directors, and in particular outside directors, contribute to the governance of a corporation is supplemented in some cases by an advisory board. An advisory board is typically composed of a number of senior business and professional people selected to provide an additional perspective on the business and plans of the corporation. The advisory board usually meets on an ad hoc basis, annually perhaps, and has no legal responsibilities to the corporation.
2. Standards of Performance
Directors derive responsibility and liability from a variety of sources. The corporation's governing statute (most often a corporate statute, but, in some cases, separate legislation such as that governing the banking or loan and trust industry) gives directors certain powers and imposes certain responsibilities, coupled with a prescribed standard of conduct. For public companies, securities and stock exchange requirements also impose duties of fairness and skill on the decisions reached by directors. These general principles are outlined in this section.
In addition to the corporate statutes, a wide array of other statutes, dealing with specific matters such as income tax or the environment, impose personal liability on directors if the corporation breaches those statutes. Further, directors may, in some restricted circumstances, be liable under general principles of common law for breach of contract or negligent misrepresentation as a result of actions taken in their capacity as directors. Directors may only be liable if they acted in such a deliberate and reckless way that they made the wrongful acts their own as distinct from the company's. For example, in the M & L Travel Ltd. case, the Supreme Court of Canada recently held the directors of a private corporation personally liable for a breach of trust by the corporation because they had full knowledge of the actions of the corporate trustee and, thus, knew of the breach of trust. By contrast, in Peoples Jewellers, an Ontario court struck out a claim against the Peoples directors personally for negligent misrepresentation in connection with the issuance of debentures because the directors had always acted in their capacity as directors and never in their personal capacity. This decision is currently under appeal.
(a) Fiduciary Duty
Directors are fiduciaries of the corporation they serve. This long-standing common law principle governs all aspects of the directors' relationship to the corporation and is codified in the corporate statutes in the requirement that directors

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act "honestly and in good faith with a view to the best interests of the corporation" in exercising their powers and discharging their duties.
The fiduciary relationship dictates a strict standard of conduct which includes loyalty and good faith and requires directors to avoid putting themselves in a position where their duty to act in the best interests of the corporation conflicts with their self-interest. The obligation is a broad and flexible one. For example, it precludes directors from taking advantage of opportunities which could be opportunities for the corporation.
Most directors, particularly independent or outside directors, have interests and activities beyond their function as directors which could on occasion give rise to a conflict of interest, or the appearance of such conflict. Notwithstanding the general principle, the corporate statutes prescribe a procedure for directors to deal with a limited number of circumstances in which their outside interests come into conflict with the corporation's interests. These are discussed in Part II.
A director's responsibilities to the corporation are not diminished, and may not be compromised, by other relationships the director may have. This applies to directors who are nominated by particular parties such as a major shareholder, a class of shareholders, a creditor or employees. A director's fiduciary responsibility to the corporation, rather than to a particular shareholder or other constituency, is the overriding principle governing the director's behaviour.
Holding multiple directorships may also put a director in a position of conflict. A director who serves on more than one board must be constantly vigilant about potential conflicts. Directors are not legally precluded from accepting several appointments, but they must carry out their fiduciary obligation to each corporation they serve. However, such directors may find themselves in a position of conflict of interest at some point, resulting in a potential breach of their fiduciary duty to one corporation or the other. Specific requirements apply when there are dealings between corporations that have mutual directors.
The recent Ontario Court of Appeal decision in PWA v. Gemini demonstrates the difficult position in which directors with conflicting interests may sometimes find themselves. PWA's nominees on the Gemini board of directors were involved in negotiating a transaction with another party that would have affected Gemini in a "vital aspect of its business". A majority of the court concluded that although PWA's nominees did not have to disclose all aspects of their negotiations, they were required to disclose that part of the negotiations that would have a serious and adverse impact on Gemini. By failing to disclose this information, PWA's nominees breached their fiduciary duty to Gemini. The court also held PWA responsible for this breach because it instructed its nominees to act contrary to their fiduciary duty. The PWA nominees were truly in a difficult position because they owed a conflicting duty to PWA to keep the negotiations confidential. In circumstances where the PWA nominees had to participate in the negotiations, they could only have avoided liability to Gemini by resigning from the board before becoming privy to the information they ultimately had a duty to disclose to Gemini. If the PWA nominees did not have to participate in the negotiations, they could have avoided liability by adopting procedures that would have prevented them from becoming privy to such information in the first place.
Inside directors, typically the chief executive officer of the corporation and one or more other senior executives, have the same fiduciary duty to the corporation as independent directors. This fiduciary obligation may put inside directors in the uncomfortable position of having to resist the wishes of a controlling shareholder. Although corporate statutes and courts pay considerable attention to the participation of outside directors in board matters because of their objectivity and independence, this focus on outside directors does not diminish the obligation of inside directors to adhere to the same fiduciary standards.

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(b) Care, Diligence and Skill
In discharging their duties, directors must "exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances". In Canada, directors cannot contract out of these responsibilities and may be personally liable for any breach of these duties. The requirement that directors exercise the care, diligence and skill of a reasonably prudent person is a general principle which appears vague, but becomes clearer in the context of how directors are expected to act in particular circumstances. Each of the three elements � care, diligence and skill � has significance. The standard can be achieved by any director who devotes reasonable time and attention to the affairs of the corporation and exercises informed business judgment.
The standard of care is measured against the objective standard of what a reasonably prudent person would do in comparable circumstances. This requires directors to devote the necessary time and attention to be able to bring their own judgment to bear on the matter and make an informed decision. A notable example of a board which failed to meet this standard of care was the board of Trans Union Corporation. In the leading U.S. case of Smith vs. Van Gorkum, this board's conduct in considering a merger led the court to conclude that the directors had been grossly negligent and were, therefore, personally liable. The Trans Union board met and approved a merger proposal after a twenty-minute presentation and a two-hour discussion. The directors had no prior notice that the meeting would be considering the proposed merger and had not informed themselves about how the merger price had been determined or about the intrinsic value of the corporation. Furthermore, the board did not request or receive any legal advice or a fairness opinion, nor did it consider or reserve the right to solicit higher offers.
Directors may find that the standard of care will be applied more strictly in certain situations. The American courts have referred to a heightened duty of care in the context of certain transactions, such as a management buy-out with its attendant self-interest. In Canada, too, boards have recognized the need to act with particular care in such circumstances by appointing special committees of directors to scrutinize the transaction. In applying the standard of care, the courts' concern has been primarily, but not exclusively, one of process rather than result. If the directors have sufficient information concerning the issue before them, examine the information critically and take the time to make an informed decision, the courts are reluctant to interfere with the result. If the directors make a decision which may be debatable from a business perspective, or if the matter simply turns out badly, the courts will not normally criticize the directors. This broad principle is sometimes referred to as the "business judgment rule", discussed below. On the other hand, directors may find themselves liable for failing to meet their standard of care if there is evidence that they did not give sufficient thought to the decision or were otherwise not diligent.
The diligence directors must exhibit in discharging their duties does not mean they will be liable for every error. Rather, they must discharge their duties with the same diligence as a reasonably prudent person would use in comparable circumstances. Failure to meet the standard often stems from a failure to inquire. It is usually not sufficient for directors to rely on their personal knowledge of the corporation instead of detailed information about the matter before them. Directors must ask for, and are entitled to receive, all the information they believe necessary to make careful decisions. Diligence requires actively questioning management and advisors, as well as engaging experts where necessary and carefully reviewing their reports. Directors who ask questions and are misled or misinformed will still have acted diligently if it was reasonable for them to expect that they could rely on the responses. Behaving diligently provides directors with a defence to liability under many statutes. Directors are also entitled to dissent from any decision of the board and to have that dissent recorded. Under many statutes, this will relieve the director of any liability for the results of that decision.

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The skill which directors must exercise in discharging their duties is that of a reasonably prudent person. There is no requirement for a director to have any particular level of education, experience or professional designation. However, directors must employ whatever ability, education, experience and training they do possess in the manner in which a reasonably prudent person would employ those skills in comparable circumstances.
This is not to suggest that professionals who serve on boards of directors are required to provide professional advice. For example, the role of a lawyer on a board is to offer business advice and judgment, not to give legal advice. Such advice should properly be provided by counsel to the corporation who is an expert in the relevant area of law. However, lawyers who are directors may not ignore legal issues which they recognize, or fail to use their legal training to question closely the legal advice given by the corporation's counsel.
Inside directors and directors who serve on committees of the board are faced with similar concerns. These directors will be better informed about some aspects of the corporation's affairs, and this knowledge must be applied in testing management's recommendations and reaching decisions about the corporation's affairs.
In its consideration of the Standard Trustco case, the Ontario Securities Commission, a regulatory body which has asserted the right to review directors' conduct in some circumstances, stated that directors who were members of the audit committee should bear somewhat more responsibility than other directors for a compliance deficiency in the corporation's financial statements. This increased responsibility arose not because the members of the audit committee were subject to a greater standard of care, but because they had more opportunity to obtain knowledge about and to examine the affairs of the corporation than did other directors. As a result, the Ontario Securities Commission decided that more was expected of them in overseeing the financial reporting process and warning other directors about problems.
(c) Business Judgment
American courts have developed a presumption that directors have acted properly in making a business decision if they acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation, and without fraud or self-dealing. If the party challenging a board's decision rebuts any element of the presumption, the directors must prove the fairness of their decision. The result is that U.S. courts do not interfere when the directors have made careful, informed decisions. Further, they assume directors have done so until the contrary is proven.
Although they have not specifically adopted the U.S. business judgment rule, Canadian courts have reached much the same result. The KeepRite case is a good example of how a court may review a business decision by a board of directors, but will not interfere with it if the decision was properly made and was not oppressive. In that case, minority shareholders challenged the corporation's decision to acquire assets from one of its subsidiaries. An independent committee of the board had concluded that the decision was fair to the corporation asa whole, including the minority shareholders. The court placed a great deal of weight on the process by which the board came to its decision and in particular took into account the fact that the matter had been considered by an independent committee of the board. The court consequently found no reason to question the business judgment of the directors. The trial judge, supported by the Court of Appeal, stated:
Business decisions, honestly made, should not be subjected to microscopic examination. There should be no interference simply because a decision is unpopular with the minority.
A recent Ontario case demonstrating a court's deference to the directors' business judgment is Benson v. Third Canadian.

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When reviewing the merits of a board's business decision, a court may ask whether the directors had an honest belief, on reasonable grounds, that the transaction in question was in the best interests of the corporation. In other words, there must have been a legitimate business purpose for the transaction. Some courts have understandably required more than a mere assertion of good faith on the directors' part. If challenged, directors will likely be required to demonstrate that they considered and based their actions on what they truly believed were the best interests of the corporation.
The Canadian business judgment rule does not offer quite the same protection as its American counterpart largely because of the availability in Canada of the oppression remedy which is available whether or not a board follows the proper process in making a decision. This remedy is available to shareholders, creditors and others who can show that a board's decision is oppressive or unfairly prejudicial to or unfairly disregards their interests. In determining whether a particular decision of a board was oppressive, the court must necessarily evaluate the business decision made by the board.
In the case of Palmer v. Carling O'Keefe, Carling O'Keefe amalgamated with a company established by Elders to acquire Carling O'Keefe. The court was asked to consider the impact of the amalgamation on the holders of the preference shares of Carling O'Keefe. The object of amalgamating the two companies was to move the debt incurred to make the acquisition into Carling O'Keefe. In order to protect the interests of the preference shareholders, sufficient funds to redeem the preference shares were set aside in a separate trust account. The court decided that the transaction had no business purpose for Carling O'Keefe. It concluded that the transaction was unfairly prejudicial to, and unfairly disregarded the interests of, the preference shareholders and that the directors of Carling O'Keefe had breached their duty to act for the benefit of the corporation as a whole. The oppression remedy is discussed in greater detail in Section 5 of this part of the guide.
3. To Whom are Directors Accountable?
Directors are required by corporate statutes to discharge their duties "with a view to the best interests of the corporation". Traditionally, this phrase has been interpreted to extend only to the corporation as a whole. However, in reaching many decisions, directors will be confronted with a number of competing interests, in addition to those of the corporation. In recent years, Canadian courts have been prepared to give directors more scope in considering the interests of different persons affected by corporate acts. The courts recognize that acting with a view to the best interests of the corporation does not mean that directors must disregard the interests of other parties or "stakeholders" who may be affected by the actions of the corporation. Stakeholders include a corporation's shareholders, but may also include its employees and creditors, and the community or country in which the corporation carries on business. Nevertheless, directors may not act contrary to the interests of the corporation in order to advance the interests of a stakeholder.
Some statutes may impose other types of accountability on the entities they regulate. Ontario's loan and trust legislation, for example, requires directors to have due regard to the interests of the depositors and the persons for whom the corporation acts in a fiduciary capacity, as well as the interests of the shareholders, in considering whether a particular course of action is in the best interests of the corporation as a whole. Directors of these corporations must, therefore, take these interests into account, and may also consider the interests of the other stakeholders in formulating a course of action.
(a) Interests of the Shareholders
The KeepRite decision is representative of Canadian cases stating that directors owe a duty to the corporation and not its shareholders. However, if a shareholder believes that the actions of the corporation have been unfairly prejudicial to its interests, it has recourse to the oppression remedy described below. In many

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instances the distinction is not significant, since what is good for the corporation will also benefit its shareholders. Maximizing the return to shareholders is also in many cases consistent with the best interests of the corporation.
Nevertheless, there can be instances where the interests of the corporation and its shareholders diverge. The interests of the common shareholders may be in realizing a short-term gain on their investment, a goal which the directors may conclude is not necessarily in the long-term best interests of the corporation. In the situation of a take-over bid, discussed in greater detail in Part III, it is not clear whether the directors have an obligation to maximize the return to shareholders by ensuring that shareholders receive the highest possible price for their shares. Further, the interests of the majority shareholders may not be the same in every case as the interests of the corporation. For instance, a controlling shareholder may want the corporation to take certain action which may be in its interest, but not necessarily in the best interests of the corporation. Developing the right solution to these kinds of issues will depend very much on the facts of each case.
(b) Interests of Other Stakeholders
Directors recognize that their decisions have an impact beyond the corporation and its shareholders. Employees and the community will be affected by a decision to close a plant. Debentureholders may be affected by high-risk business strategies or by corporate reorganizations. The national interest may be affected by a decision to move operations offshore. Directors may feel a responsibility to consider the interests of these stakeholders. The modern interpretation of a director's duty to the corporation permits directors to consider these interests in coming to a decision about what is in the best interests of the corporation. In its judgment in Teck, the Supreme Court of British Columbia confirmed that directors could consider interests other than those of the corporation:
If today the directors of a company were to consider the interests of its employees, no one would argue that in doing so they were not acting bona fide in the interests of the company itself. Similarly, if the directors were to consider the consequences to the community of any policy that the company intended to pursue, and were deflected in their commitment to that policy as a result, it could not be said that they had not considered bona fide the interests of the shareholders.
Certain American jurisdictions have statutes permitting directors to consider interests other than those of the corporation or the shareholders as a whole. Some states permit (and, in circumstances such as take-over bids, require) directors to consider the interests of employees, suppliers, creditors and consumers. Some states include local and national economies and society as a whole in the interests to be considered. Suchlegislation was enacted in the wake of high levels of take-over activity in the 1980's (particularly by non-Americans) and was, at least in part, a response to decisions facing boards of directors which had significant implications for stakeholders of the corporation other than shareholders. At present, there is no equivalent Canadian legislation.
4. Reliance on Management, Financial Statements and Advisors
In discharging their responsibilities directors are not expected to have first hand knowledge of all aspects of the affairs of the corporation. The board delegates to management and is entitled to rely on the information prepared by management, including the financial statements. Similarly, directors are not required to be expert in technical areas of the corporation's business. They are entitled to rely on reports of internal or external experts, such as lawyers, accountants and appraisers.

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(a) Reliance on Management
The law recognizes that since directors must delegate much of their responsibility to the corporation's management and since directors are dependent on management for virtually all of the information they have about the corporation, the directors must be entitled to rely on management and what it tells them, when it is reasonable to do so. Directors may assume that the officers have performed their duties honestly, but only if they have no grounds for suspecting otherwise. The Ontario Securities Commission's Standard Trustco decision emphasized that 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 reasonable grounds for doubting management's ability to make objective recommendations to the board on a particular issue. In those circumstances, directors must ensure that they are justified in relying on the information being provided to them.
(b) Reliance on Financial Statements
Many of the decisions made by a board of directors are based on a particular understanding of the financial condition of the corporation. In assessing the corporation's financial condition, directors are dependent not only on the integrity of the internal financial systems, but also on management which prepares the financial information or statements, and on the auditors who review that process and the statements. The role of the board of directors in ensuring that the financial statements are accurate is discussed in Part II.
Directors are entitled under the corporate statutes to rely on the financial statements under two conditions. First, they must rely on the statements in good faith. Second, the financial statements must have been represented to the directors to fairly reflect the financial condition of the corporation, either by an officer of the corporation or in a written report of the auditor of the corporation. If these conditions are met, directors who rely on the financial statements in reaching their decision are specifically exempted under the corporate statutes from liability for a number of breaches of those statutes, including liability for employee wages, and even from liability for breach of their fiduciary duty.
(c) Reliance on Advisors
Just as they are entitled to rely on the financial statements of the corporation, directors are entitled to rely on the corporation's advisors and will avoid certain liability under the corporate statutes for actions taken in reliance on these advisors. Again, this reliance must be in good faith. Moreover, directors may only rely on a report of a person "whose profession lends credibility" to the statements made by that person. Lawyers, accountants, engineers and appraisers are examples given in the statute, but other types of financial advisors as well as environmental consultants can also be included in this category. An Ontario court recently confirmed the propriety of a board's actions taken on legal advice in Benson v. Third Canadian.
Directors should confirm that the expert or advisor is qualified to give the advice sought and that the expert or advisor had access to and considered the information relevant to the advice. Directors may not be entitled to rely on other directors with expertise in a given area unless the director is specifically retained for that purpose. Reliance on the views of a lawyer on the board, for example, will not provide directors with a defence unless that lawyer is also retained as counsel.
It is incumbent upon the directors to question outside advisors closely on their advice. In one American decision, for example, the court found that it was not sufficient for directors to rely on a conclusory oral opinion of the corporation's investment bankers about whether the option price for certain assets was within a range of fair value. The directors did not require a written fairness opinion, nor did they inquire what the range was or about the effect of the transaction on the corporation's future.

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In some situations, the board must hear directly from outside advisors rather than delegate responsibility for seeking outside advice to management. This may be the case, for example, where the issue is a material one to the corporation or where management may have some interest in the advice being given. In some cases, it may even be appropriate for the directors to hear from and question the advisors in the absence of management.
Finally, the TSE Corporate Governance Committee suggested that every board of directors should implement a system to enable an individual director, subject to appropriate board committee approval, to engage an outside advisor at the corporation's expense in appropriate circumstances. The Committee recognized that individual directors may wish to dissent from a board decision, may believe that the direction the board is taking is wrong, or may otherwise be concerned about their personal liability for corporate actions and may, therefore, need to consult with independent legal, financial or other advisors.
5. Taking Action Against the Directors
The corporate statutes provide several ways for shareholders and other interested parties to take action against directors. The first is the oppression remedy, available to parties who believe they have been unfairly dealt with by a corporation. The second is the derivative action, which allows a third party to require the corporation to take action against the directors. Finally, a third party may apply to the court for an order compelling the directors to comply with the corporation's articles, by-laws or governing statute.
(a) Oppression
The oppression remedy is a very broad remedy available to a complainant where the corporation or the board has acted in a manner which was oppressive or unfairly prejudicial to, or which unfairly disregarded that person's interests. A complainant may be a current or former security holder, creditor, director or officer of the corporation or any of its affiliates, or any other person who the court agrees is a proper person to bring an oppression action. The oppression remedy permits parties to protest corporate action which they consider unfair. If a court finds oppression, it may make any order it considers appropriate to remedy an oppressive or unfair situation.
The corporate statutes do not provide any objective definition of oppression, but the courts have developed a list which, though not exhaustive, provides some guidance about what constitutes oppressive behaviour:
€ lack of a valid corporate purpose for a transaction;
€ lack of good faith on the part of the directors of a corporation;
€ discrimination between shareholders that benefits the majority shareholder to the exclusion or detriment of the minority shareholder;
€ lack of adequate and appropriate disclosure of material information to minority shareholders; and
€ conflict of interest between the interests of the corporation and the personal interests of one or more directors.
As discussed above, the oppression remedy is particularly important for directors because their decisions may be censured if the court finds them oppressive or unfairly prejudicial, even though, in some instances, the court may also find that the directors acted in accordance with the law, the articles and by-laws of the corporation and their fiduciary duties. There need not be evidence of bad faith on the part of directors for a finding of oppression. While a court will consider the integrity of the process by which the transaction was approved and undertaken, it will also consider the substantive effects of the transaction on the complainant.

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In the Westfair Foods Ltd. case, the directors approved the payment of dividends, constituting all the earnings of the corporation, to the holder of all the corporation's common shares. That shareholder then loaned the money back to the corporation. Both the payment of dividends and the borrowing of money was within the power of the directors, and the court did not find that these powers were exercised improperly or that the court was entitled to question the business decision to pay out dividends and then finance expansion by borrowing. The court did, however, find that in the circumstances the procedure adopted by the board exemplified an unfair disregard for the interests of the other shareholders who were entitled only to fixed dividends, but who shared rateably with the common shareholder on liquidation. This is also an example of what has become characterized as a related party transaction. Such transactions may require particular procedures to be followed by the board to assist in being able to demonstrate that it acted in good faith.
In Palmer v. Carling O'Keefe, discussed above, the court found that there was no bad faith involved in the decision to amalgamate the two companies, and that the board, composed of experienced business people acting upon independent advice, had exercised its best business judgment with respect to the transaction. The court concluded that the impugned conduct nevertheless constituted oppression because it was unfairly prejudicial to the interests of the holders of preference shares and because it did not serve the interests of the corporation, only the interests of the controlling shareholder.
(b) Derivative Action
There may be circumstances in which a shareholder or creditor wishes to seek redress on behalf of the corporation for the directors' breach of the corporation's rights. Since the shareholder or creditor would not be considered an aggrieved party, it could not bring an action without the mechanism described below. For example, where the directors have breached their fiduciary duty to the corporation, a shareholder could arguably not launch a suit since the fiduciary duty is owed to the corporation and not the shareholder. However, the shareholder may still be able to sue the directors on behalf of the corporation by way of a derivative action.
A court will not give a complainant leave to bring an action unless the complainant first gives the directors reasonable notice of its intention to bring a derivative action and the directors do not cause the corporation to bring and diligently prosecute the action. The court must further be satisfied that the complainant is acting in good faith and in the best interests of the corporation.
The derivative action is used far less extensively than the oppression remedy, in part because a successful derivative action may result in an award of damages or other remedy to the corporation, whereas an oppression action may result in an award to the complainant.
(c) Compliance Orders
If a corporation or a director, officer, employee or agent of the corporation breaches its governing corporate statute or the articles, by-laws or a unanimous shareholder agreement of the corporation, a complainant may apply to a court for an order directing compliance or restraining the breach. Most often petitions for compliance orders are coupled with oppression actions, and the judgments have tended to be based on oppression rather than compliance.

ood corporate governance is integral to directors discharging their responsibilities. In a general sense, "corporate governance" refers to the process and procedures used to manage the business and affairs of a corporation. It relates to internal matters such as the operation of the board as well as external matters such as the corporation's relationship and dealings with shareholders.
For the purpose of its report, the TSE Corporate Governance Committee defined corporate governance as the process and structure used to direct and manage the business and affairs of the corporation with the objective of enhancing shareholder value, which includes ensuring the financial viability of the business. The process and structure define the division of power and establish mechanisms for achieving accountability among shareholders, the board of directors and management. The direction and management of the business should take into account the impact on other stakeholders such as employees, customers, suppliers and communities. One of the principal themes of the TSE Report is the empowerment of individual directors. The TSE Report states that effective corporate governance requires every board of directors to have in place appropriate structures and procedures to ensure that the board can function independently of management.
The way in which corporate governance issues are handled depends on the corporation in question and its circumstances at the time an issue is being considered. Some general guidelines for dealing with these issues can be distilled from the corporate statutes, the case law and the evolving standard of good practice that has developed in Canada and elsewhere. This part describes corporate governance issues and outlines certain guidelines for dealing with them.
1. Membership of the Board
(a) Number of Directors
The size of a board is dictated by the needs of the corporation and norms developed in certain industries. A board should have enough directors to represent a variety of skills and perspectives and to provide experience useful to the board in managing the corporation. It may also be necessary or desirable to represent a number of constituencies on the board � for example, representatives from different provinces, industries or shareholder groups. There must be enough directors to serve on various committees of the board without overburdening any individual director or making it impossible for directors to discharge their responsibilities. However, a board should not be so large that its meetings become unwieldy. There may also be a danger of individual directors losing their sense of direct responsibility if they are part of a very large board

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where they do not have sufficient opportunity to make the contribution they feel is appropriate.
According to Conference Board of Canada studies, boards of Canadian corporations average 12 members, two of whom are normally inside directors, that is officers of the corporation or an affiliate. Boards of foreign-owned subsidiaries tend to be smaller than those of Canadian-controlled corporations. Boards of public companies tend to be larger than boards of private companies. Boards of the major banks tend to be very large, with as many as 30 or more directors.
The TSE Committee's Final Report expressed some concern about the size of many boards. Its Guidelines suggest that every board of directors should examine its size with a view to determining the impact of size upon effectiveness and, where appropriate, put in place a program to reduce the number of directors to a size that facilitates effective decision-making. A number of institutional investors have issued proxy guidelines that state that they are of the view that boards of public companies should not typically be comprised of more than 15 or 16 directors.
(b) The Independent Director
Most boards have a combination of "inside" and "independent" or "outside" directors. Independent directors and the role they play has recently received increased attention from those concerned with accountability in corporate governance. The corporate statutes define an independent director as any director who is not employed by the corporation or one of its affiliates. Under this definition, a variety of persons, including retired employees of the corporation and representatives of a controlling shareholder, major creditors, customers or suppliers of the corporation would qualify as independent directors, notwithstanding their potential conflicts of interest. Further, the term "affiliates" involves the concept of control and, therefore, directors or employees of a major, but not controlling, shareholder are technically independent under the corporate statutes.
In practice, the meaning of the term "independent director" is different than the definition in the corporate statutes. Determining whether a director is independent involves a consideration of whether there is a material connection between the director and the corporation which could hamper the director's ability to make objective judgments. Any relationship between a director and the corporation � past, present or anticipated � could compromise at least the perception of that director's independence if not that director's actual independence. It can be difficult to judge when this somewhat intangible line is crossed; but whether or not a particular director is independent in fact, the perception that a director is independent is important to shareholder confidence and to a court's review of the procedural aspects of a board's decision. For these reasons, the practice of a number of public companies, influenced in part by securities regulation policies, is to narrow the class of persons considered to be independent directors.
The Canada Business Corporations Act requires public companies to have no fewer than 3 directors, 2 of whom must be independent directors. On a board of 12, then, a CBCA corporation could legally have 10 inside directors. Other statutes are more restrictive. For example, Ontario's Business Corporations Act requires that at least one-third of the directors of a public corporation not be officers or employees of the corporation or any of its affiliates. The Bank Act requires that at least one-third of the directors have no affiliation with the bank. The number of bank employees who may sit on the board is also limited.
In recognition of the importance of independence in the corporate governance process, the TSE Report focused on this issue. The Report introduced a new concept of "unrelated" directors. These are directors who are free from any interest and any business or other relationships (other than interests and relationships arising from shareholding) which could, or could reasonably be perceived to, materially interfere with the directors' ability to act with a view to the best interests of the corporation. One of the most significant recommendations that

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the TSE Corporate Governance Committee put forward was that every corporation should constitute its board of directors with a majority of individuals who qualify as unrelated directors. In proposing this Guideline, the Committee indicated that it was responding to the concern that the board be able to bring objective judgment to the assessment of management and to the assessment of the merits of management initiatives.
The TSE Corporate Governance Committee also addressed the constraints on individual director's decision-making which can sometimes result when board members are related to the corporation's significant shareholder. For purposes of the TSE Report, a significant shareholder is deemed to be a shareholder with the ability to exercise a majority of the votes for the election of the board of directors. While the Committee accepted a significant shareholding should not, in itself, make directors related, the Committee's Guidelines recommend that the boards of companies that have a significant shareholder should also include a number of directors who do not have interests in or relationships with either the corporation or the significant shareholder and who fairly reflect the investment that shareholders other than the significant shareholder have in the corporation. This is a change from the Committee's initial draft report which recommended that a significant shareholder should be considered related. Although some people believed it was time to have a general rule that boards have a majority of unrelated directors on this broader basis, the Committee adopted the current Guideline based on extensive public comment.
Increasing the number and responsibilities of independent directors has become an accepted way of addressing many corporate governance issues. Independent directors are perceived to be in a better position than inside directors to make objective decisions and to assess management recommendations because they have less personal interest in those decisions and recommendations.
(c) Chair
Most boards appoint a chair who is responsible, among other things, for managing the board, setting the agenda, ensuring that directors are kept informed and running the meetings. In many corporations, the chief executive officer is also the chair. Other corporations prefer to have an independent director chair the board. In some cases, this may assist the board to function more independently from management because, for example, the chair can control the agenda for board meetings. The chair is a key liaison between the board and senior management. Increased concern about board accountability and process have made the separation of these two functions the subject of greater debate.
The Cadbury Report on corporate governance, released in Britain in December 1992, recommends a clear division of responsibilities between the chief executive officer and the board chair to ensure a balance of power and authority and to prevent any one individual from having unfettered powers. In Canada, the conventional view had been that the separation of the two functions, while desirable, is somewhat less critical than in Britain where boards have tended to have fewer independent directors than Canadian boards, making the separation of functions more important in establishing checks and balances.
The TSE Report stressed the importance of the board's ability to function independently of management. The TSE Corporate Governance Committee suggested that the simplest means for so empowering board members would be through the appointment of a non-executive chair of the board. The Committee expressed a preference for the appointment of a non-executive chair, but stopped short of elevating this preference to the status of a Guideline. The Committee recognized that alternative structures such as assigning this responsibility to a board committee or to an independent "lead director", could achieve the same objective, namely enabling the board to function effectively independently of management.

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Various institutional investors have issued guidelines recommending that the position of chair of the board and chief executive officer be separated.
(d) Qualification
Convincing qualified candidates to serve on a board of directors can be difficult. In part, this is because of the time commitment involved. Recently, directors have become more concerned about the potential personal liability they assume when they agree to serve on a board, as illustrated by the publicity surrounding the resignation of directors from the boards of a number of companies in financial difficulty.
The corporate statutes impose minimal qualifications for directors. Any individual who is 18 or over, who has not been found by a Canadian court to be of unsound mind and who does not have the status of a bankrupt, is qualified to be a director of a Canadian corporation. Where a director has been convicted of certain offences, a court or a regulatory authority may prohibit that person from serving as a director for a period of time.
Although no longer common practice, the articles of a corporation may require directors to hold shares of the corporation. However, since the shareholdings of directors are required to be set out in certain documentation provided to shareholders, it is considered good form in some public companies for directors to hold shares to demonstrate confidence and interest in the corporation and its management.
A majority of directors must be resident Canadians, and some provinces require that one or more directors of a corporation governed by the provincial corporate statute be resident in the province. As discussed above, a specified number of directors must be independent directors if any of the corporation's securities are publicly held.

Corporations look for a number of qualities in their independent directors. Experience and judgment are foremost among those qualities. Independent directors are often successful business people, with experience which either spans a number of industries or is in an area relevant to the corporation. They may also be from government, politics or academia, depending on the needs and interests of the corporation. Although directors are not expected to have the expertise necessary to directly manage the business themselves, it is important that some, if not most, have some background in the issues which the corporation faces. Directors may be professionals such as lawyers, although advisors to the corporation will need to consider carefully whether they should serve on the board of a corporation which they advise. The practice varies. Some corporations prefer no member of the firm which acts as the corporation's outside counsel be on the board. Others require that other lawyers in the firm and not the lawyer who is the director give legal advice to the corporation and its directors. In some instances, this distinction is not made and lawyers serve as directors and give legal advice to the corporation.
Since the Canadian business community is comparatively small, most board appointees are recommended by other directors or by senior officers of the corporation. There are also several executive search firms which assist in locating and selecting new board appointees, particularly where the corporation wishes to have a special constituency represented on the board.
One issue is the role of senior management in selecting board members. Again, the goal is to create a balance between management and the board in managing the corporation. It is common for a board to appoint a nominating committee to select appropriate candidates.
The TSE Report recommended that nominating committees be composed exclusively of non-management directors with the responsibility not only for proposing new nominees, but also for assessing directors on an ongoing basis.

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Institutional investors have also endorsed the proposition that there be a nominating committee composed of non-management directors.
As an important element for new directors, the TSE Corporate Governance Committee also recommended that every corporation provide an orientation and education program for new recruits to the board. Such a program could be a one or two-day event which would familiarize the director with the nature of the business, current issues within the company, the corporation's strategy,the company's expectations concerning input from directors, and directors' general responsibilities. The Committee suggested that such a program should also include the opportunity to discuss with experts a director's responsibilities and those of the board as a whole, as well as the opportunity to visit facilities and to meet with corporate officers in order to develop a better appreciation for the business. The Committee was of the view that these measures would allow directors to contribute effectively from the outset of their appointment.
(e) Election and Term
Normally directors are elected by a simple majority of shareholders at the annual meeting. The slate of directors is put forward by the corporation in the management information circular which is approved by the directors and which must accompany the proxy form sent to shareholders for the annual meeting. Shareholders typically vote for (or withhold votes from) the proposed slate of directors rather than vote for or against individual candidates, although the proxy form also provides an opportunity for shareholders to cross out names if they wish to withhold their vote from a particular director. While it is open to the shareholders to nominate persons at the annual meeting, in practice this seldom happens. If it does, such person is rarely elected because the proxy procedures usually result in the majority of votes being given to management and, therefore, being voted in favour of the proposed slate. Further, in many Canadian corporations, there is a controlling or majority shareholder which will effectively elect the proposed slate.
The articles of a corporation may provide for cumulative voting for directors. In this case the articles must provide for a fixed number of directors rather than simply stipulating a minimum and a maximum number, which is permitted where there is no cumulative voting. Cumulative voting entitles each shareholder to cast one vote for each share held, multiplied by the number of directors to be elected. By casting all of these votes in favour of one candidate, a shareholder (or a group of shareholders) with sufficient voting shares will be able to elect at least one director, even though the shareholder does not control a majority of the votes. This helps shareholders, particularly minority shareholders, to elect directors representative of their interests in proportion to the percentage of the voting shares they control. However, very few corporations have adopted cumulative voting.
The articles of a corporation may also provide for a particular class of security holders, such as preferred shareholders, to elect one or more directors. For the most part, however, these shareholders only have the right to elect a representative if there has been some unusual event, such as the corporation's failure to pay dividends on preferred shares for a specific period.
Agreements among major shareholders may also affect the election of directors. Shareholders sometimes agree to support each other's nominees for election to the board, usually in proportion to their overall shareholdings. Occasionally, majority shareholders may also agree to support one or more representatives of the minority shareholders.
Directors may be elected for terms of up to three years, although it is more common for directors to be elected each year by the shareholders at the annual meeting. Directors need not all be elected at the same time or for the same length of time, but may be elected for staggered terms.

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Surveys show that directors tend to serve for a number of terms. Most directors serve for at least five years and many serve for 10 years or more. Many corporations have compulsory retirement for their directors. Where there is no particular retirement age, directors tend to retire at about age 70.
(f) Remuneration
Directors' remuneration is usually set by the board. Independent directors are normally paid an annual fee along with a certain amount for each board meeting or committee meeting they attend. According to published surveys, annual fees paid to directors in Canada average about $10,000 per year and the fee paid per board meeting averages about $800 per meeting, plus travel expenses. An average additional per meeting fee of $200 to $300 (or, in many public corporations, the same amount as for full board meetings) may be paid to members of board committees for each committee meeting they attend, and an additional annual amount averaging $3,000 to $4,000 may be paid to the chairs of those committees. These average amounts tend to be somewhat lower than the amounts paid by many Canadian public companies and lower still than fees paid to directors of American corporations. Inside directors are not normally remunerated separately for their service on the board. Amounts for directors' fees are being reconsidered by corporations in view of the time spent by conscientious directors on the affairs of the corporation and, in particular, the potential liability to which they are exposed. However, increased remuneration may lead to a perception of diminished independence if fees are seen as the main reason for individuals wishing to serve on a board.
The TSE Report expressed concern about the increasing risk associated with being a director as corporate and director accountability are treated ever more seriously by the investing public. The TSE Corporate Governance Committee also noted that the public's increasing expectations of directors is leading to greater demands on a director's time. Accordingly, the Committee stated that each board should review the adequacy and form of the compensation paid to its directors in order to ensure that the compensation reflects the responsibilities and risks associated with being an effective director.
(g) Vacancies
If there is a vacancy on the board, the remaining directors may continue to transact business as long as there is a quorum. If they wish, the remaining directors may fill the vacancy unless the articles, by-laws or corporate statutes provide otherwise. If the board is left without a quorum, the remaining directors must call a special meeting of shareholders to elect the required number of directors.
If a class or series of shares is entitled to elect certain directors and a vacancy occurs among those directors, the other directors elected by that class or series may normally fill that vacancy. If there are no other directors elected by that class or series, a holder of those shares may call a meeting to fill the vacancy.
(h) Resignation and Removal
Directors cease to hold office when they die, resign or are disqualified under the corporate statute or removed from office. A resignation is effective at the time the director sends it to the corporation or at the time specified in the resignation, whichever is later, but it cannot be effective prior to the time it is tendered. Directors may make a written statement to the corporation about their reasons for resigning which the corporation must either send to the shareholders or include in the management proxy circular. If a director of a financial institution governed by the Bank Act resigns as a result of a disagreement with other directors or officers, the director must submit a written statement to the Superintendent of Financial Institutions describing the disagreement.
Directors may be removed from office by a majority of shareholders at a meeting of shareholders. The directors themselves may call a shareholders' meeting for this purpose, or

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shareholders holding at least 5% of the issued and outstanding shares may requisition such a meeting. If the articles of the corporation provide for cumulative voting, a director may not be removed from office if the votes cast against removal would be sufficient to elect that director at an election where the full number of directors required by the articles was being elected. Similarly, directors elected by one class of shareholders may only be removed by a vote of that class. Directors who are being removed may submit a written statement to the corporation giving reasons why they oppose this action and the corporation must provide this statement to the shareholders as it would if the director had resigned.
Although shareholders have the ability to remove directors, as a practical matter, directors are seldom removed in this way except in the face of a proxy battle or other hostile transaction.
2. Board Meetings
(a) Frequency
The frequency with which a board meets will vary from one corporation to the next. It will also depend, in part, on the particular corporate activities requiring specific board attention and on the number of matters which are dealt with primarily by committees of the board as opposed to the full board. Most companies schedule their full board meetings at regular intervals, such as each quarter, often coinciding with the need to deal with matters such as quarterly financial information and dividends. If a corporation is involved in a major restructuring, financing or acquisition, it may be necessary for the board and perhaps one or more of its committees to meet more frequently to consider and approve a particular course of action. The various committees meet around these general board meetings as required to satisfy their particular committee mandates.
Regular meetings of a board are often half-day or day-long events. If a meeting has been called for a specific purpose, it may be quite brief or it may last significantly longer than a regular meeting.
(b) Notice of Meeting, Attendance and Written Resolutions
All directors are entitled to receive notice of all meetings of the board and no director may be excluded from such meetings. Except for certain matters specified by the corporate statutes and subject to the corporation's by-laws, there is no general technical requirement to specify in notices the matters which will be discussed at the meeting. However, as a practical matter, notices do specify such matters and include considerable detail and background. Unless notice is given in accordance with the corporation's by-laws or statutory requirements, the board meeting is not duly constituted and the business conducted at that meeting is of no effect. For this reason, where a board meeting must be called quickly and there is not sufficient time to give the required notice, the corporation may ask directors who were not present at the meeting to sign a waiver of notice. A director's presence at the meeting constitutes waiver of the notice requirements.
Attendance at board meetings is central to the discharge of a director's responsibilities. Dates of meetings of the board are normally set well in advance, in order to allow directors to schedule all their affairs. Unless directors attend meetings, participate in discussions with other members of the board and question management, they are unlikely to be fully informed about the affairs of the corporation and cannot expect to be in a position to meet the standard of care and diligence imposed on them. In some jurisdictions, the corporation is required to disclose in the proxy materials how many meetings each director attended.
Directors should also bear in mind that they will be deemed to have consented to any board resolution passed in their absence unless they dissent in the manner prescribed by statute (described under "Voting" below), and that they will be liable along with all the other directors who did not dissent for the acts and omissions of the board.

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In Canada, unlike many jurisdictions outside North America, directors may not appoint proxies to act in their place. Although less common for public companies, directors may act by way of written resolution of all the directors.
(c) Location and Telephone Meetings
Meetings are often held at the corporation's head office, but many boards make it a practice to vary the location of their meetings. Where directors do not all live locally, board meetings may be moved around to accommodate them. Holding meetings in a variety of locations may also permit directors to visit and meet with management located away from head office or with local business and government officials. Some statutes require that a majority of meetings be held in Canada.
Most corporate statutes now permit meetings to be held by conference telephone. Depending on the governing corporate statute, the directors may be asked to consent to telephone meetings when they first agree to act as directors, or they may need to consent each time a telephone meeting takes place. In spite of the convenience of such meetings, there is a value to directors meeting in person. If a number of directors are participating by telephone, it may be difficult to determine who is speaking or how the participants are reacting to the comments of others. Meeting in person around a board table is often preferable to a phone meeting because it is more likely to facilitate frank and open debate.
(d) Quorum
A quorum must be present at any board meeting for business to be conducted at the meeting. The articles or by-laws of the corporation will usually specify the quorum. If they do not, the quorum requirements set out in the corporate statutes will apply. Regardless of the size of the quorum, a majority of those present must be resident Canadians. Alternatively, the action taken at the meeting must subsequently be ratified by one or more directors whose presence would have constituted a quorum for the purposes of the Canadian residency requirement had that director been present at the meeting. Provisions of the articles or by-laws setting out the quorum requirements typically provide that no business may be conducted at a meeting of the board unless there is a quorum present.
(e) Voting
Unless the articles or by-laws provide otherwise, action is normally taken by a board on the basis of a simple majority vote by the directors who are present. However, there may be circumstances in which the board decides it is appropriate or desirable to have a more significant majority or even unanimous approval of the board before proceeding.
The minutes of a board meeting will often simply record the passage of a motion. Directors who disagree with the decision must be aware that they are deemed to have consented to the action unless they dissent. Abstaining does not constitute dissent. A director who has abstained from voting will be deemed to have consented to the resolution, except in the case of certain conflicts of interest where abstention is permitted by statute. A director's dissent must be recorded in the minutes, or the director must request it to be recorded. Alternatively, the director may send a written dissent to the secretary of the meeting before the meeting is adjourned, or to the corporation after it is adjourned. If a director was not present at a meeting at which the board took certain action with which the director disagrees, the director must either have a dissent placed with the minutes of the meeting or send a written dissent to the corporation within 7 days after becoming aware that the resolution was passed.
A director who dissents in accordance with the procedures prescribed by statute will avoid certain liability. For example, the provisions of the corporate statutes making directors liable to the corporation for issuing shares improperly or paying dividends, redeeming shares or giving financial assistance contrary to the statutes only impose liability on directors who voted for or consented to the action.

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(f) Minutes
The corporation is required to keep minutes of board meetings and directors are entitled to see the minutes. The minutes will provide evidence of who was present and what was done at a meeting. It is, therefore, important that they reflect the meeting accurately. It is also important that minutes be circulated promptly after a meeting has been held. This will allow directors who were present to confirm the accuracy of the minutes while the meeting is still fresh in their minds and permit directors who were absent to register their dissent, if necessary, as promptly as possible.
There has been debate from time to time about the extent to which discussion at a meeting should be recorded in the minutes. Minutes are seldom an exhaustive record of everything said at a meeting. However, some description of the nature of the discussion may provide helpful evidence that the board's consideration of an issue was thorough and thoughtful. On the other hand, extensive record keeping may inhibit full and frank discussion.
No matter what level of detail is included in the minutes about the board's discussions, the minutes should, at the very least, be an appropriately complete record of the decisions taken at the meeting. If the board received advice from experts or advisors, this should be noted in the minutes. They should also indicate any dissent expressed by a director. The minutes of a meeting of directors will be very persuasive evidence in any subsequent proceeding challenging the directors' conduct in respect of a particular decision.

3. Delegation
As noted at the outset, the board of directors is not usually in a position to directly manage the day-to-day affairs of the corporation and it, therefore, delegates to others. It delegates not only to management, but also to committees of the board and sometimes involves other committees composed, in whole or in part, of non-board members. In delegating their responsibilities, directors must be satisfied from a business perspective that the task being delegated is best handled by the person or committee to whom it is delegated.
Certain responsibilities are generally considered sufficiently important that directors may not delegate them to a committee of the board. Under the Canada Business Corporations Act these include:
€ making changes to the by-laws (which would be subject to shareholder approval in any event);
€ approving the financial statements, a management proxy circular, a take-over bid circular or directors' circular;
€ issuing securities (except on terms already approved by the board);
€ declaring dividends; and
€ purchasing or redeeming shares of the corporation.
Some corporate statutes also prohibit directors from delegating the appointment or removal of the chief executive officer, chief financial officer, president and chair of the corporation. Regardless of the responsibilities delegated to a committee of the board, certain matters falling within the mandate of that committee may nevertheless be matters which should properly be returned to the full board for consideration, such as matters of policy or issues outside the ordinary course of the corporation's business. In practice, the committees of many boards do not formally approve the matters before them, but return the matter to the full board with their recommendation.

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(a) Board Committees
Committees of the board allow directors to share responsibility and to devote the necessary resources to a particular issue or area. All public corporations are required by statute to have an audit committee and private corporations frequently choose to have an audit committee as a matter of good practice. Many corporations also have an executive committee. A compensation committee is becoming an increasingly common and important committee, dealing not only with executive compensation, but with the implementation of procedures to comply with other matters such as pay equity legislation. Some corporations also have other committees such as a nominating committee, a corporate contributions committee, a planning committee or a committee to deal with public policy or social responsibility. In light of the importance of environmental matters, many boards have constituted a committee to deal with environmental matters. The TSE Report suggested that corporations establish a corporate committee to assume responsibility for governance issues affecting the corporation, including the corporation's response to the Guidelines set out in the Report. Many boards also strike ad hoc or special committees from time to time to address specific issues or transactions.
The size of the committee will depend on its mandate. While a committee needs to have enough members to represent different perspectives and a variety of backgrounds, it must also be an efficient working group with its membership ideally confined to as few members as possible. The committee's composition will depend on the nature of the committee.
If an independent committee is struck, the board should appoint those directors who are completely at arm's length from the matter the committee is considering. Under the Canada Business Corporations Act a majority of the members must be Canadian residents. If the committee is studying some aspect of the corporation's business or a specialized area such as environmental issues, the members of the committee should be those directors most familiar or best qualified to deal with the matter.
A committee of the board will normally be established by a resolution of the board. That resolution should set the mandate for the committee and describe the scope of its authority, including whether it may engage and pay its own advisors. Committees will often be entitled to determine how their meetings are conducted, what the quorum is to be and how often they will meet, absent any requirements in the corporation's by-laws dealing specifically with such matters.
(b) Audit Committee
The financial statements are the most important information shareholders receive about the corporation's affairs. They are prepared by management and approved by the board before being submitted to the shareholders. The corporate statutes require public companies to have the annual financial statements audited. This provides further assurance that the statements present a fair and balanced view.
Under corporate statutes the audit committee is responsible for reviewing the corporation's annual financial statements before they are presented to the full board for approval. Securities legislation requires the audit committee to review, and the board to approve, all financial statements (including interim financial statements) in a prospectus. In practice, the mandate of the audit committee has expanded far beyond these statutory responsibilities to include overseeing the corporation's continuous financial disclosure obligations, monitoring the corporation's financial systems and procedures and meeting with the auditors to review management's financial stewardship.
Although corporate statutes do not require boards or audit committees to approve interim financial statements, in practice, the majority of public companies have interim financial statements reviewed by the audit committee and approved by the board.

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Under the corporate statutes, the audit committee must be composed of at least 3 directors, a majority of whom must be independent. Audit committees are strongly recommended by both the Canadian Securities Administrators and Britain's Cadbury Report. In practice, audit committees are typically composed entirely of independent directors. The TSE Report recommended that every audit committee be composed only of outside directors. The audit committee's roles and responsibilities should be specifically defined so as to provide appropriate guidance to its members as to their duties. The audit committee should have direct communication channels with the company's internal and external auditors so that they might discuss and review specific issues as appropriate.
There is no requirement that members of the audit committee have any expertise in financial matters. However, members of the audit committee must be sufficiently versed in financial matters to understand the corporation's accounting practices and policies and the major judgments involved in preparing the financial statements.
The number of meetings of an audit committee varies. Audit committees sometimes meet only once or twice a year, but the frequency of their meetings is increasing in many corporations because of greater expectations imposed on them. The audit committee typically meets with management and the auditor before the annual audit begins and again before the financial statements are approved by the board. Meetings of the audit committee are normally attended by the corporation's chief financial officer and the auditor as well as by the committee members. The audit committee should require the chief financial officer to report at each of its meetings on matters relevant to the financial state of the corporation. The auditor also has a key role to play in the process, helping the audit committee understand the quality and extent of the information provided by management for inclusion in the corporation's financial statements. The auditor also assists in reviewing and assessing the financial systems and controls necessary to ensure the integrity of the financial information.
The relationship between the audit committee and the auditor must be one of trust and candour. The auditor is appointed each year by the shareholders at the annual meeting. Only the shareholders may remove an auditor from office. If there is a vacancy in the office of auditor, the directors are required to fill the vacancy, unless the shareholders have done so at the meeting at which they removed the auditor or unless the corporation's articles stipulate that only the shareholders may fill a vacancy in the office of auditor. If an auditor resigns or is about to be removed or replaced, the auditor may submit a written statement to the corporation giving the reasons for its resignation or why it opposes being removed or replaced. Public companies must also comply with the reporting requirements of National Policy No. 31 of the Canadian Securities Administrators and must disclose any disagreement between a corporation and its auditor that has been a contributing factor to the resignation or termination of the auditor.
Auditors have come under considerable scrutiny in recent years, as have audit committees and the role that they play in ensuring that financial statements represent the financial position of the corporation in a fair and balanced manner. In 1986, the Canadian Institute of Chartered Accountants established the Macdonald Commission to study the public's expectations of audits. The Treadway Commission was established in the United States in 1987 for a similar purpose. Both commissions highlighted the importance of establishing systems within the financial reporting process and emphasized the importance of continuous disclosure systems in addition to systems for the annual financial statements. Both commissions also confirmed the importance of the role of the audit committee and recommended increased responsibilities for that committee. The report of the Macdonald Commission, released in 1988, was followed by a notice issued by the Canadian Securities Administrators which echoed many of the recommendations made in the Macdonald Commission report.

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Much of what the Macdonald Commission recommended and the Canadian Securities Administrators adopted was already the practice in many Canadian corporations. These recommendations included assigning responsibility to the audit committee for, among other things:
€ reviewing the annual audited financial statements with management and the auditor before making recommendations to the board;
€ reviewing changes in accounting principles and practices followed by the corporation;
€ reviewing all financial reports that require board approval before their submission to securities commissions; and
€ reviewing the financial content of all sections of the annual report to ensure consistency with the audited financial statements.
In addition, the Macdonald Commission's report advocated a number of functions for the audit committee to strengthen audit effectiveness. These included recommendations about:
€ appointing the auditor after consultation with management;
€ reviewing the auditor's estimated and actual audit fees;
€ discussing the scope and timing of audit work with the auditor, and reviewing any problems encountered by the auditor;
€ reviewing with the auditor any significant recommendations for internal controls the auditor makes to management; and
€ reviewing management's response to its recommendations.
Increasingly, audit committees are being called upon to assume responsibility for monitoring the corporation's ongoing financial disclosure. For example, Canadian securities regulators recommend that audit committees review interim financial information before it is released to the public. Audit committees are also taking on increased responsibility for monitoring the internal systems and controls of the corporation and the activities of internal auditors. Internal auditors typically focus on financial controls and internal operating information. In order to monitor their activities, the audit committee must understand and approve the objectives of the internal auditors, their annual audit plan and their areas of emphasis. The audit committee should question management about its risk assessment and allocation, environmental and security controls, compliance with regulatory requirements, and general standards of business conduct. The TSE Report suggested that the audit committee's duties should include responsibility for overseeing management reporting on internal control. The Report noted that while it is management's responsibility to design and implement an effective system of internal control, it is the audit committee's responsibility to ensure that management has done so.
(c) Special Committees
A special committee is an ad hoc committee of the board established to consider a particular issue. If the committee is to consider an issue involving a conflict of interest for certain directors, the committee will usually be composed entirely of directors who are independent for the purposes of the issue under consideration. Special committees have become one of the most important ways a board of directors can establish that it has gone through the appropriate process and given an issue thorough, balanced consideration before reaching a decision.
Special committees have long been used as a matter of good corporate governance, but they are now receiving added currency from securities regulators and legislators. Ontario Securities Commission Policy 9.1 recommends the use of a special committee where the corporation is considering certain transactions with a related party. The Bank Act requires a special committee composed of independent directors to be established on a

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standing, rather than an ad hoc, basis to establish procedures for the review of related party transactions.
The establishment of a special committee is not, of course, in and of itself sufficient to discharge the board's duty to carefully and independently review a matter. The composition of the special committee, the time it has to consider a matter, its access to information and its use of advisors will also be factors in determining whether the board has discharged its duty through the use of the special committee.
The KeepRite decision highlighted the important role that special committees play in good corporate governance. In that case, KeepRite was pro posing to acquire assets from a subsidiary. The KeepRite special committee reviewed the proposed transaction and made a recommendation to the board that the transaction was fair to the corporation and to minority shareholders. The corporation sought and obtained shareholder approval, but the minority shareholders who were opposed to the transaction nevertheless sued. One of the reasons the court gave for concluding that the transaction was not oppressive was the consideration given to the matter by a committee of independent directors.
4. Directors' Conflict of Interest
Directors may have a number of relationships which will put them in a position of conflict or give rise to an obligation to disclose details of a relationship.
(a) When Does a Conflict Arise?
Directors who have an interest in a contract or proposed contract with the corporation must consider the matter from two perspectives. First, if the contract is material from the corporation's perspective, the directors will be under a statutory obligation to declare their interest and, with some exceptions, to refrain from voting on the matter. Second, if directors do vote on the matter, they must ensure that they do not have a conflict of interest. Voting on a matter in these circumstances would constitute a breach of their fiduciary obligation to act in the best interests of the corporation.
Under the corporate statutes, directors have an interest in a contract not only if they themselves are a party to the contract, but also if they have a material interest in any person who is a party to the contract. The statutes do not define when a director has a material interest in a person, but material interest is generally interpreted to mean an interest which is sufficient to result in some benefit to the director.
Directors who are also substantial shareholders of the corporation are not automatically in a position of conflict. Such directors must, however, separate their role as directors from their interests as shareholders. In voting on matters in their capacity as shareholders, those directors may of course vote without regard for the interests of other shareholders. In acting as directors, however, they must still take into account the best interests of the corporation in respect of any matter before them.
The corporate statutes require directors to disclose in writing to the corporation their interest in any material contract or to request that the interest be entered in the minutes of a meeting of the board. Whether the contract is material will be determined by the materiality threshold in respect of the circumstances of the corporation itself.
The nature of a director's interest must be disclosed in sufficient detail to allow the other directors to understand what the interest is and how far it goes. A director's interest must also be disclosed within the time frame prescribed by the relevant corporate statute.
(b) Voting and Abstaining from Voting
Directors cannot normally vote on a contract in which they have a material interest. There are exceptions for contracts which involve the directors' remuneration or an indemnity in which

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they have an interest. Exceptions are also made if the contract in question relates to security for money lent to the director or obligations undertaken by the director for the benefit of the corporation or if it relates to an affiliate of the corporation. As a result of this last exception, directors who serve on boards of affiliated corporations are not required to refrain from voting on contracts between the two corporations which they serve.
Two results may flow from a director's failure to disclose an interest in a material contract or, in some cases, from voting when not entitled to do so. First, the director may be required to account to the corporation or its shareholders for any gain or profit realized from the contract. Second, the corporation, its shareholders or, in some cases, securities regulators may apply to the court to have the contract set aside. Under some statutes, the director may nevertheless avoid these results if the contract is confirmed or approved by special resolution of the shareholders after appropriate disclosure of the director's interest in the contract. If the director failed to make the necessary disclosure and the contract was not reasonable and fair to the corporation at the time it was approved by the shareholders, there is no protection for the director under the corporate statute.
Directors should be aware that the specific provisions in the corporate statutes dealing with a director who is in a position of conflict apply only in relatively limited circumstances. They apply only to certain contracts or proposed contracts with the corporation and would, arguably, not include litigation, for example. Further, these provisions apply only to contracts that are material to the corporation, not to contracts that do not meet this threshold.
In practice, however, most directors apply the rules broadly. They do not confine the restrictions to the statutory requirements, but concern themselves with the issue of perceived, as well as actual, conflict and what seems to be the right thing to do. In practice, directors will take themselves completely out of the consideration of a particular matter where there may be a perception of conflict or a perception that they may not bring objective judgment to the consideration of the matter. In appropriate circumstances, directors will declare their position and absent themselves not only from the vote, but also the discussion. However, directors should be aware that abstaining from voting, except in certain limited circumstances, may not protect them from liability under the corporate statutes. In particularly difficult situations, it may be necessary or appropriate for a director to resign.
5. Confidential Information
(a) Corporate Opportunity
As noted in Part I of this guide, directors must avoid even a perception that they have appropriated an opportunity that belonged to the corporation. If directors take advantage of an opportunity of which they become aware by virtue of their position as directors, and that opportunity is one in which the corporation might conceivably have had an interest, the directors have acted counter to their fiduciary duty to the corporation.
The leading Canadian case on corporate opportunity is Canaero. The discussion of the Supreme Court of Canada in this decision captures the essence of the fiduciary nature of the relationship between directors and the corporation. The court found that two senior officers were in breach of their fiduciary duty to the corporation for taking personal advantage of an opportunity which they learned about through their relationship with the corporation. The court held that they had breached their fiduciary duty to the corporation, even though they had resigned prior to taking up the opportunity. It did not matter that the corporation was not in a position to take on the contract at the point it was awarded to the two former officers and that the corporation, therefore, suffered no loss. The court decided that it was necessary to apply the fiduciary standard strictly against directors and senior management in recognition of the degree of control which their positions give them in the corporation's operations.

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(b) Duty of Confidence
and Insider Trading
Directors also have a duty of confidence towards the corporation. They must not misuse information obtained from the corporation by virtue of their position on the board. A duty to keep such information confidential arises where the information is confidential by nature and was communicated in confidence. Ultimately, the best interests of the corporation will dictate the manner in which directors can use information received in their capacity as directors.
Coupled with this duty of confidence is the statutory prohibition on insider trading which prevents directors from profiting by trading in securities with information which they have about the corporation and certain other entities as a result of their position as directors until that information has been generally disclosed. The requirements of the insider trading rules and the associated penalties are described in Parts III and IV.
6. Information Management
(a) Information Provided to Directors
Since directors are responsible for the management of the corporation, they are entitled to have access to any information belonging to the corporation. The flow of information to directors is critical to the discharge of their responsibilities. A balance must be struck between keeping the directors informed of significant issues facing the corporation and providing them with the information needed to come to informed views, and providing the directors with so much information that their time is devoted to sifting through that information in an attempt to distill what is truly relevant. In his 1986 report on the collapse of the Canadian Commercial Bank and the Northland Bank, the Honourable Willard Estey found that the inability of the board of the Canadian Commercial Bank to perform its duty was directly related to the improper flow of information to the board:

If there is one key to the troubles encountered by the Board in directing the affairs of the bank, it was their composite failure to insist upon simple and straightforward regular and timely information from management. The institutions and processes were in place in the government of the day, but they did not function because management did not deliver and the Board did not demand a flow of the basic information necessary to the control of the affairs of the bank and to keep management within the policies as laid out by the Board.
Frequently, it is the chief executive officer of the corporation who, in the first instance, determines what information is provided to the board. The chair of the board, if this is someone other than the chief executive officer, should also be involved in this decision. It is critical that the directors receive the information in sufficient time to allow them to read and digest it. The amount of time needed will vary depending on the volume and complexity of the information.
(b) Financial Statements
Responsibility for the corporation's financial statements is one of the board's most significant responsibilities, as these statements are the primary means of communicating the performance and prospects of the corporation to shareholders and prospective investors. The board's review of the financial statements must be more than a pro forma perusal of statements prepared and reported on by management. It is incumbent on the directors to review the statements with a view to identifying any indications that the corporation is encountering difficulty. In its Standard Trustco decision, the Ontario Securities Commission criticized a board of directors for inappropriately approving financial statements and disseminating this information publicly.

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The board should question members of the audit committee, management, the auditors and any other advisors, such as legal counsel, about the financial statements. It might be appropriate, for example, for the directors to question the appropriateness of the corporation's accrual policy or management's decisions to write down certain assets or not to do so. Many of the accounting firms have developed sample questions for boards and audit committees to provide some guidance on the types of questions which will help directors shed light on the financial statements.
The importance of the financial statements is reinforced by the regulatory requirement that a corporation explain much of what is contained in the financial statements in a narrative referred to as management's discussion and analysis of financial conditions and results of operation, or the "MD&A". Although the MD&A is described as management's discussion, it is an adjunct to the financial statements, which are the board's responsibility, and is incorporated into corporate documents such as the annual report. Therefore, it is important that the board be both familiar and comfortable with the disclosure. The role of the directors in the preparation of the MD&A is discussed in greater detail in Part III.
(c) Timely Disclosure
Because a key tenet of the public markets is equal access to material information, the timely public dissemination of information dealing with the operations and activities of a publicly-traded corporation is one of the fundamental obligations of such corporations. The board should be satisfied that procedures are in place to ensure that the corporation is satisfying its timely disclosure obligations and that the information being disseminated is true and accurate. These requirements are discussed in greater detail in Part III.

Although the TSE Corporate Governance Committee stopped short of recommending legislating civil liability for the timing and content of releases concerning material changes, the Committee believed that the issue of such liability should receive consideration.
Following the release of the TSE Committee's draft report, the TSE established a committee in the summer of 1994 to examine possible changes to securities laws governing continuous disclosure by public companies. In particular, the committee will consider whether statutory civil liability should be imposed on directors with respect to a corporation's obligations to ensure that there is timely and continuous disclosure. If enacted, this would provide a statutory basis to enable shareholders to sue for damages stemming from inaccurate disclosure. The committee is expected to report in the summer of 1995.
7. Securities and Stock>
Exchange Requirements
Procedures followed in the past by some corporations as matters of good corporate governance are now prescribed for public companies by securities and stock exchange requirements. These are frequently policies of general application to many of the corporation's activities and must, therefore, be considered when a board is formulating the appropriate procedure for dealing with certain issues.
(a) Role of the Securities Regulator
While many of the legal requirements that affect directors and their corporations are found in the corporate statutes, Canadian securities regulators have been active in developing guidelines for corporate conduct in relation to particular transactions such as going private transactions and related party transactions. These guidelines are contained in policy statements and in decisions made in securities regulatory proceedings.

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The issue of the extent to which securities regulators can issue policy statements has been the subject of recent judicial scrutiny. This has resulted in a change in approach and in the use of rule-making as part of the process. However, as a practical matter, the extent and importance of the role of securities regulators will continue.
Securities regulators have interpreted their mandate to protect the public interest to include ensuring that corporate practice and procedures accord with public expectations, even if they go beyond the existing black letter law. Before proceeding with any significant transactions, directors should ensure that their procedures comply with the current expectations of the regulators.
(b) Stock Exchanges
Reference has been made throughout this guide to various regulatory requirements of the stock exchanges. In addition to regulating initial and ongoing listings, the stock exchanges also have requirements relating to corporate governance. These typically relate to transactions involving the issuance of shares and may require, in some instances, shareholder, including minority shareholder, approval. For the most part, the stock exchanges can enforce their rules because of their ability to refuse to list or to suspend trading in a corporation's shares. In many cases, they are also in a position to at least request that the appropriate securities commission take action against a corporation or its directors.
In December 1994, the TSE Committee on Corporate Governance in Canada delivered its Final Report to the TSE proposing Guidelines for improved corporate governance. The TSE Corporate Governance Committee recommended that all listed companies incorporated in Canada should be required to describe in their annual report or information circular their system of corporate governance with reference to the Guidelines and should include an explanation of the differences between the Guidelines and the company's system of governance.
The Guidelines consist of recommendations on the appropriate structures and procedures that public companies seeking effective corporate governance should follow. These Guidelines set out:
€ a description of the specific responsibilities that are to be assumed by every board of directors;
€ suggestions as to appropriate structure for an effective board of directors, including an appropriate number of directors unrelated to management or to a significant shareholder;
€ suggestions with respect to a number of governance-related functions to be carried out by the board, including recruiting new directors and assessing board effectiveness, assessing management, and establishing governance systems for the corporation.
The TSE Corporate Governance Committee has not recommended that the TSE require listed companies to comply with the Guidelines. Rather, the Committee proposes simply to require disclosure of differences between the company's governance systems and the Guidelines. The Committee acknowledges that the Guidelines are intended to be flexible statements of principle which corporations will adapt to their particular circumstances. This will allow each company to develop an appropriate system of governance that reflects its circumstances. The TSE has introduced a new listing requirement requiring companies to provide a discussion of their corporate governance practices, including the ways in which those practices may differ from the Guidelines.
As a side note, the London Stock Exchange participated in a study of corporate governance relating to financial matters which resulted in the Cadbury Report. The Cadbury Report contains a Code of Best Practice which it recommends corporations adopt as their guideline for corporate governance. The London Stock Exchange requires all corporations listed with it to

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adopt the Code or to provide the Exchange with an explanation for why they have not done so.
The Code of Best Practice is a four-part list of recommendations dealing with the procedures of the board of directors, the selection and role of independent directors, the term and remuneration of inside directors and the controls and reporting systems which the board should put in place. The Code is based on three general principles. The first is an open approach to disclosure of information to promote the efficient working of the market economy, to prompt boards to take effective action and to allow shareholders and others to scrutinize corporations more closely. The second principle is integrity, meaning straightforward dealing and completeness in all areas of governance, including financial reporting. Finally, accountability to shareholders is a cornerstone of the Code. The role of the board in this regard is to ensure that high quality and complete information is reaching the shareholders, who in turn have a responsibility to exercise their rights as owners. The Code and the principles on which it is based are consistent with the increased emphasis in Canada on accountability of corporations to their shareholders and the investing public.
8. The Role of Shareholders
The directors and not the shareholders are responsible for the management of the corporation. However, under the corporate statutes, certain matters are considered so fundamental that they require the approval of the shareholders. Under the Canada Business Corporations Act these matters include:
€ effecting certain amalgamations or reorganizations;
€ selling all or substantially all of the corporation's assets;
€ adding or removing any restrictions on the business that the corporation may carry on;
€ changing the corporation's share capital;
€ increasing or decreasing the number of directors or the minimum or maximum numbers of directors;
€ confirming by-laws; and
€ adding or changing restrictions on the issue, transfer or ownership of shares.
If a fundamental change affects holders of certain classes of shares differently than others, the change must also be approved by a majority of the series or class of shares whose existing rights may be affected by the change, whether or not the shares otherwise carry voting rights.
As noted above, public corporations must also comply with the requirements of the provincial securities commissions and the stock exchanges which impose requirements for shareholder approval.
Finally, there may be issues which the directors determine should be put to the shareholders as a matter of good corporate governance whether or not they are legally required to do so. The issue of whether shareholder approval was necessary to put a shareholder rights plan in place was commonly debated when shareholder rights plans first came into use in Canada. A number of boards of directors determined that the advice of the shareholders through a shareholders' vote was essential well before the view of the regulators to the same effect was known. Similar considerations will certainly arise in the future in the context of other decisions facing public companies.

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(a) Shareholder Meetings
Annual meetings of shareholders are required by law. The items for consideration at an annual meeting include the election of directors and the appointment of auditors. While the financial statements are not approved by shareholders, these are usually presented to them in conjunction with the annual meeting. Any other matters on the agenda at an annual meeting are normally determined by the board of directors and turn the meeting from simply an annual general meeting into an annual and special general meeting. The annual meeting is also the opportunity for the chief executive officer and the chair to address the shareholders and for the shareholders to question the management and board.
Publicly-traded corporations are required to send out a management proxy circular soliciting proxies from their shareholders with respect to any meeting of the shareholders. The management proxy circular provides information to shareholders about the corporation, the directors and the matters which will be put to the shareholders at the meeting. A large part of this information now deals with executive compensation. The materials sent to shareholders must provide shareholders with sufficient detail about the matters to be considered at the meeting to permit them to make a reasoned judgment about those matters.
Special meetings may be called at any time and are normally called by the directors to seek shareholder approval for a particular matter. Unless circumstances require otherwise, special meetings are often held concurrently with the annual meeting to avoid the expense and inconvenience of holding two shareholder meetings in one year. Shareholders holding at least 5% of the corporation's shares may require the directors to call a special meeting of the shareholders and, if the directors fail to do so, the shareholders may call the meeting themselves.
Shareholders may require the corporation to put a proposal before the shareholders and to have it set out in the management proxy circular. There are certain limitations on this right which are designed to prevent shareholders from using the annual meeting as a forum to promote economic, political, racial, religious, social or similar causes, purely personal matters, or to secure publicity. The limitations also prevent a shareholder from submitting the same proposal for two years after it has been submitted and defeated. However, within the statutory limits, shareholders are entitled to have their proposals put to the other shareholders, even though these proposals may not be supported by the directors.
If notice of a matter has not been put in the meeting materials, there is very limited scope for the shareholders to request the meeting to deal with the matter. At the meeting, shareholders may ask the board to consider a matter and request it be put to a vote. In many instances, this can be ruled out of order by the chair of the meeting because notice of the matter was not given in the management proxy circular. If there is a vote on the matter, it is only advisory in nature and not binding on the directors.
While experience indicates that most individual shareholders do not usually express their views on corporate performance or board decisions at meetings of shareholders, large institutional investors do communicate their views to management, in some instances, in response to questions from management. Consequently, senior representatives of corporations often meet with their institutional shareholders to explain financial results or major corporate changes. While such meetings are an accepted practice, it is important that the corporation not release material information selectively because immediate public disclosure of material information by public corporations is usually required.

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(b) Shareholder Ability to
Change the Board
Shareholders who are dissatisfied with how the directors are running the corporation may remove the directors or refuse to re-elect them. In practice this may be a difficult course to take, particularly where the shares of the corporation are widely held. Although the corporate statutes require a corporation to provide a list of shareholders to any shareholder who requests it, thereby enabling shareholders to mount a proxy battle over the election of directors, many shareholders do not have the time or resources required to counter a management proposal. The exceptions are large institutional investors who have on occasion made their voices heard at annual meetings or in private meetings with representatives of a corporation prior to a shareholder meeting. Occasionally, proxy battles do occur which result in the replacement of the board of directors.

(c) Dissent Rights
Finally, there are a number of transactions and corporate changes in which the shareholders have a right to dissent. Where shareholder approval is required for a corporation to effect a fundamental change, such as an amalgamation or continuation of the corporation into another jurisdiction, shareholders are entitled to formally dissent and to be paid the fair value of their shares. This ensures that a shareholder who opposes the transaction or corporate change is not required to accept the consequences of that change simply because two-thirds of the shareholders voted in favour.
The dissenting shareholder and the corporation must first attempt to agree on the fair value of the shares. If they do not, application may be made to the court to determine the fair value.

art I of this guide discussed the basic nature of the responsibilities of the directors to the corporation and the issues related to discharging those responsibilities. Part II outlined some of the basic corporate governance issues to which directors should be sensitive in order to ensure that their duties are being appropriately discharged. This part applies the principles discussed in Parts I and II to some of the matters most commonly considered by a board of directors.
1. Financing
Financing decisions are among the most significant for a corporation. Funds may be raised either in the form of debt or equity capital. In certain circumstances a corporation can enhance its ability to increase profits by increasing its leverage (or debt to equity ratio), but increased leverage also has the potential to magnify losses. If a corporation's capital structure is too highly leveraged or is otherwise inappropriate, it can threaten the stability of the corporation, especially during a downturn in the industry or economic cycle. On the other hand, while raising equity may contribute added stability, the dilutive effect on existing shareholders may not always be welcome. Financing decisions are generally made by the full board of directors, although there is some latitude to delegate some aspects of a financing to a board committee or specified executive.
(a) Issuing Debt
For most corporations the primary source of debt financing has traditionally been commercial bank financing. Depending on the corporation and its financing needs, these arrangements will vary from straightforward operating and term facilities to much more varied and sophisticated arrangements. During the 1980's, corporations started to make much greater use of the private and public capital markets, in Canada and in the United States and Europe, as sources for their debt requirements.
The board of directors must consider various factors in assessing specific and overall funding requirements of the corporation and sources from which this funding may be available. Financing decisions will be affected, for example, by the funds which management anticipates will be available from operations, by the level of planned capital expenditures and by the desirability of matching factors such as the life and location of assets with the term and currency of financing. The board should also consider the ratio of debt to equity which is appropriate for the corporation, the implications of additional debt on the ability to fund existing commitments and any impact on the corporation's credit rating. Most senior issuers will have their public debt and preferred shares rated by a Canadian or U.S. credit rating agency. These agencies will monitor

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the creditworthiness and other financial aspects of a corporation and attach a specified rating to each rated security. This rating in turn affects financings. The better the credit rating, the lower the cost of funds and the broader the range of potential investors.
The extent and source of debt and other capital requirements will, in the first instance, be recommended to the board by senior management, usually through the chief financial officer. In evaluating a particular loan, directors should consider the rate of interest available, whether the interest rate will be fixed or floating, and whether the facility is to be short, medium or long term. Other features of a loan, such as the currency, any security which the lender requires and any restrictive covenants, can be significant and should be carefully considered, as they may have an impact on future financing and even other corporate action.
(b) Issuing Shares
The authority to issue shares of a corporation lies with the directors, although in some instances it may be necessary to obtain shareholder approval, for example to authorize the creation of a class of shares. Shareholders cannot compel directors to issue shares and directors cannot delegate their authority to issue shares to a committee of the board unless the full board has authorized the manner and terms on which the shareswill be issued. The two classes of shares which are most often issued are common shares and preferred shares. The names assigned to shares often describe the attributes of those shares. The descriptions may include "non-voting", "subordinate voting", "participating", "redeemable" and "retractable". The attributes which these terms describe are all variations of the basic attributes of common shares and preferred shares.
Common shares are typically the corporation's voting shares. Holders of these shares elect the corporation's directors and vote on matters which are put to a shareholder vote as prescribed by statute and described in Part II. Generally they are also the "participating" shares, meaning that they are entitled to share in the profits of the corporation through dividends if, as and when the directors may determine, and to share the residual equity of the corporation on dissolution. Traditionally, the common shares of the corporation had all three attributes: the right to vote; the right to discretionary dividends; and the right to share in the residual equity of the corporation on dissolution. It is now not uncommon for these three attributes to be split. Non-voting common shares, for example, do not carry the right to vote, but are generally fully participating.
The capital invested in the corporation in the form of common shares is generally considered to be permanent capital of the corporation. Holders of common shares may sell their shares, but the capital remains invested in the corporation. Unlike many preferred shares, the terms of common shares by definition do not typically include provisions for investors to have their capital returned to them through redemption or retraction of the shares.
As the name implies, preferred shares have some form of preference or other priority over more junior classes of shares, including common shares. The priority usually relates to dividends and return of capital. Preferred shares may also have other features, such as a right of conversion, which in effect gives them some of the attributes of common shares and a set dividend rate.
Preferred shares may be issued for an indefinite term. Alternatively, they may have a fixed-term, be redeemable at a specified time or times by the corporation or retractable at specified times by the holder. A fixed-term or a redemption right exercisable at the option of the holder, referred to as a "retraction right", can affect the characterization of the preferred share by credit rating agencies and the market generally. While preferred shares have traditionally been considered permanent equity, the use of fixed-term or retraction features have resulted in such preferred shares being viewed for some purposes as more akin to debt than equity and, therefore, a further factor to assess in considering the appropriate debt to equity mix.

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The determination of the appropriate preferred share terms, including the dividend rate and whether the share should be permanent equity or have a specific term or retraction right, will be significantly influenced by variables in the marketplace and in the corporation's circumstances at the particular time of financing. To meet this need for flexibility in setting the terms of preferred shares, the articles of a corporation may authorize one or more classes of preferred shares and then empower directors to set the specific terms of the preferred shares which can be issued in one or more series of the already established class. This provides an important degree of flexibility to the corporation.
(i) Purpose and Consideration
Directors must be satisfied that shares are being issued for a proper business purpose. Most often the purpose is to raise capital or acquire assets for the corporation, but some boards have used their ability to issue shares as a defensive tactic against a party who wishes to take control of the corporation. In situations where the directors believe, in good faith, that issuing shares to effect or to prevent a change of control is in the best interests of the corporation, the courts have accepted this as a proper business purpose. Issuing shares in order to entrench the existing board has not, however, been held to be a proper business purpose.
Directors must also be satisfied that shares are being issued for adequate consideration. This can be a particular issue when common shares are being issued because their value can be difficult to assess, even where there is a public market. There are a number of ways to value shares. The value of publicly-traded shares will generally be based predominantly on their recent trading history, but market prices can be affected by a variety of factors which may not be completely reflective of their underlying value. Further, introducing additional shares into the market and the corresponding dilution of existing shares may have an impact on the price which new investors will be prepared to pay for those shares. The pricing of the shares is sometimes done with the advice of the corporation's financial advisors who are experts in the area. Failure to ensure that the cash consideration paid for shares is adequate exposes directors to personal liability under the corporate statutes.
If shares are being issued as consideration for property or past service, directors must be able to conclude that the property or past service is worth at least what the corporation would have received if the shares had been issued for cash. This applies, for example, where shares are being issued in exchange for assets being acquired by the corporation or to employees or directors in lieu of cash compensation. Again, in making this determination the directors may look to the advice of advisors or other experts. Failure to ensure that the value of the property or past service is adequate also exposes directors who voted for or consented to the resolution to personal liability under the corporate statutes.
(ii) Shareholder Approval Required
Although the corporate law empowers the directors to issue shares from the corporation's authorized share capital without consultation with the shareholders, there will be some circumstances in which the issuance of shares will nevertheless be subject to shareholder approval. This may be imposed in some cases by the stock exchange on which the shares of the corporation are traded. For example, in most instances corporations listed on The Toronto Stock Exchange (the "TSE) must receive the prior approval of the TSE before they issue shares. The TSE may make this approval conditional on shareholder approval. For example, if the TSE thinks that the transaction could materially affect control of the corporation or if the transaction has not been negotiated at arm's length, shareholder approval may be required.
The related party rules applied by the securities commissions may also give rise to the need for shareholder approval. For example, Ontario Securities Commission Policy 9.1 may require shareholder approval if there is a share issuance in a related party transaction. In addition,

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While the directors may incur personal statutory civil liability for a prospectus, they also have certain defences. The most significant defence available to directors is the "due diligence" defence. In this context, due diligence means that directors will not be liable if they conducted a reasonable investigation to have reasonable grounds for the belief that there was no misrepresentation. This in turn has been interpreted to require an appropriate degree of verification including, in appropriate circumstances, independent verification. All directors may not necessarily be able to take advantage of this due diligence defence. The conventional view is that inside directors will likely not be able in the normal course to utilize the defence given their more direct and day-to-day involvement in the corporation's affairs. The liabilities associated with the prospectus and the defences available are discussed further in Part IV.
Particularly significant for the outside directors is the general view that the diligence, and related verification, may be delegated to someone else to perform on the directors' behalf. In practice, depending on the issuer and the nature of the offering, the diligence exercise is carried out by management working with a combination of outside or inside advisors who are effectively acting on the directors' behalf. It is important for the directors to be satisfied that the appropriate due diligence process is in place and has been followed.
This may be a particular issue when corporations are financing through a short form prospectus, or other accelerated public offering techniques. As discussed below, in these circumstances the opportunities for performing due diligence are more limited given the shorter time frame and there is, of necessity, generally more reliance on the corporation's internal procedures for review and preparation of prospectus related materials.

(iii) Proceeding with a Public Financing -
The Long Form Prospectus
The prospect of a public or other financing will often be discussed, at least in a general way, at meetings of the board of directors well in advance of a preliminary prospectus being prepared or filed. For example, potential financing sources are often indicated when the corporation's business plan or capital expenditure program are considered by the directors. For most corporations, the actual timing of a prospectus financing is difficult to predict. While some corporations are in businesses which permit such financings to be scheduled, for the most part the markets are volatile and the exact timing of a public financing is difficult to determine very far in advance.
When a prospectus financing is to be undertaken, the preliminary prospectus is usually prepared by members of management with varying degrees of involvement by the underwriters and outside legal advisors. It is unlikely that any of the independent directors will see a draft of the preliminary prospectus until shortly before the meeting at which they will be asked to approve it. At this point the preliminary prospectus is nearing its final form. Nevertheless, the preliminary prospectus should be submitted to the directors sufficiently in advance of the meeting to allow them time to review it adequately. The amount of time required will depend on the circumstances, such as whether the corporation is a first time or infrequent issuer as compared to a seasoned or more frequent issuer that more regularly prepares or updates its prospectus related material.
If the corporation is undertaking its initial public offering or "IPO", or if the corporation is public but not in the prompt offering system, the prospectus will be in the traditional "long form". The long form prospectus includes a great deal of information prescribed by securities regulations, including a comprehensive description of the corporation's business and its financial position, as well as all other information about the corporation which could affect the price or value of the securities being offered. If the issuer is raising capital in the public markets for the first

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time, a careful review of the due diligence process and the prospectus is particularly important.
Directors must read the prospectus carefully and ask questions, as appropriate, of management, legal counsel, the auditors and any experts whose opinions are disclosed in the prospectus on any points with which they are unfamiliar or about which they wish confirmation. As noted, directors are not required to conduct their own full scale review or audit on the matters disclosed in the prospectus in order to discharge their duties and will, of practical necessity, rely primarily on the efforts of the internal and external advisors. However, directors will be expected to have reviewed the prospectus carefully, including the financial statements, and be satisfied with information disclosed or not disclosed through the assurances of management and advisors and, equally important, the process followed in its preparation and verification.
Counsel to the corporation will normally advise the directors of their obligations in connection with the prospectus and, particularly in long form offerings, will provide a form of directors' and officers' questionnaire to them posing a number of questions, both specific and general, about the prospectus.
After the directors have approved the preliminary prospectus, it is filed with the securities commissions for review. Once the comments of the securities regulators have been settled, a final prospectus is approved by the directors and filed with the commissions. It is not appropriate for the final prospectus to be approved by the board at the same time as the preliminary prospectus for two reasons. First, the directors must approve the changes made to the prospectus in response to the comments of the regulators. Second, the directors must confirm that nothing has occurred between the filing of the preliminary prospectus and the filing of the final prospectus which requires disclosure. However, in many circumstances it can be difficult for the entire board to meet again, either in person or even by conference call, in order to approve the final prospectus. In most circumstances the corporation and the underwriters will want to file a final prospectus as soon as the regulators' comments have been settled; however, the actual timing of settling these comments is always somewhat uncertain. In anticipation of this, a board may delegate, in accordance with applicable corporate law, the responsibility to approve the final prospectus to a committee of the board, such as an executive committee. Delegation of this function does not relieve the directors who are not on the committee of liability in the event that a misrepresentation appears in the final prospectus which was not in the preliminary prospectus approved by the full board. Further, while many matters may be delegated to such a committee, there are limitations in the corporate law on the powers of committees of a board to set the specific terms of a security to be offered. Depending on these limitations, it may be necessary to have the full board approve the final prospectus.
(iv) Proceeding with a Public Financing -
The Short Form Prospectus
One of the most significant developments in prospectus financing in Canada was the introduction in the early 1980's of the short form or prompt offering prospectus system. For most senior issuers, it has transformed the public offering process. The conventional long form prospectus system takes as much as three months to complete. The increasing volatility of the markets and the need to respond to "windows" in the market made this time frame a significant constraint on the ability of corporations to access the public markets. In addition, much of the information to be included in the prospectus of a seasoned issuer was already in the public domain through other public filings.
The short form system responds to these points by allowing eligible issuers to use an abbreviated or short form of prospectus and incorporate by reference into that document disclosure documents previously filed with the securities commissions containing material facts about the corporation, such as the annual information form and the financial statements. A

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corporation is eligible to use the prompt offering system if it has a one-year public reporting history and a specified minimum public market equity capitalization, and is not in default of any requirement of the securities legislation in the relevant jurisdiction.
New disclosure about the corporation in the short form prospectus will usually be confined to a "recent developments" section dealing with matters which have occurred since the corporation's last filings. As a result, there is usually relatively little information about the corporation itself in the short form prospectus. The balance of the short form prospectus will describe the securities being issued and the details of the offering. However, the documentation which is incorporated by reference should also be reviewed by directors to ensure it continues to be accurate and, to the extent it is not, further disclosure may have to be included in the short form prospectus. Directors are subject to liability for information incorporated by reference into the short form prospectus.
A further refinement of the short form system is the introduction of "shelf" prospectus procedures which can further accelerate and facilitate the public offering process. Under this system a base or shelf prospectus is filed setting out in general terms the securities that can be issued. Once this base prospectus is filed and cleared, securities can be issued, or "brought down off the shelf", virtually immediately and without any further regulatory review. Shelf prospectuses are typically used for various forms of debt financing, such as medium term note programs, which are sold in frequent intervals at prevailing market rates.
In addition to permitting a shorter and simpler offering document, the short form system also significantly reduces, or in the case of the shelf system effectively eliminates, the time frame for regulatory review.
Short form prospectus financing has been significantly affected by a related development, the advent of the so-called "bought deal" underwriting. Under this process the underwriter commits to purchase the corporation's securities without the traditional "market out" clauses which allow the underwriter to withdraw from a transaction if it is unable to successfully market it. While such market out clauses reduce the underwriter's risk, they provide a degree of uncertainty to the issuer about whether it will receive the amount of money it is seeking on the terms that were agreed. The bought deal reduces this uncertainty and means the underwriter has an increased need to eliminate its underwriting risk as quickly as possible. In order to do so, there is even further demand to prepare and file the prospectus documentation as quickly as possible.
All of these factors have assisted corporations in accessing the capital markets. However, the responsibilities of the directors and their potential statutory civil liability remain the same. This further highlights the need for the directors to be satisfied that the system and process that the corporation has in place to ensure the accuracy of the prospectus are appropriate and provide not only appropriate disclosure to the marketplace, but also offer them a basis for establishing their due diligence defence.
(d) Dividends
A key ongoing aspect of the financing process is the declaration of dividends on the corporation's shares. Dividends are declared at the discretion of the board of directors. The exercise of this discretion is subject to the directors' fiduciary duty and duty of care, diligence and skill. In addition, directors may not declare a dividend if there are reasonable grounds for believing that the corporation would not meet certain statutory solvency tests if the dividend were paid. If dividends are declared contrary to these statutory limitations, the directors can be jointly and severally liable to the corporation for any amounts paid and not otherwise recovered by the corporation. This is discussed in greater detail in Part IV.

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(i) Discretion to Declare Dividends
The directors are under no obligation to declare dividends � even on preferred shares whose terms include a cumulative dividend at a specified rate. This is an important distinction between a dividend on a share and an interest payment on a debt, which is a legal obligation of the corporation over which the directors have no inherent discretion. Shareholders cannot compel directors to pay a dividend. This is consistent with the principle that the corporation is an entity distinct from its shareholders, with interests and needs which may or may not be consistent with those of its shareholders. When funds are available, it is the board's prerogative and responsibility to decide whether to declare a dividend or to use the money for other corporate purposes.
Certain shares, such as preferred shares, may have a right to receive preferential dividends. The right to receive these preferential dividends is not, however, a legal right to receive dividends, but, rather, a right to receive a dividend, if it is declared by the directors, before a dividend is paid on certain other classes of shares. Once again, the directors cannot be compelled to declare these dividends. Similarly, the fact that a corporation has historically paid dividends on a particular class of shares does not create any legal obligation to continue to pay such dividends.
When cash is not available, directors may decide to borrow to finance a dividend. This may be done, for example, in order to keep the capital markets receptive to the corporation's securities. The directors will generally be acting properly in borrowing for this purpose, provided that the borrowing is in the best interests of the corporation and the corporation satisfies the solvency tests notwithstanding the borrowing and payment of the dividend. Courts have recognized that a corporation may have sufficient assets to justify the payment of a dividend, but not have the cash available to pay it.

The same dividends must be paid upon all shares of a given class, but where a corporation has different classes of shares the board may declare dividends on one class of shares and not others, subject to whatever priority or other limitations are imposed by the articles of the corporation. Subject to its commitments to pay dividends to its preferred or other prior ranking shareholders, and provided it complies with the solvency tests, the corporation may pay any amount as a dividend to the corporation's common or other participating shareholders. Decisions of this nature will be subject to the general duty of the directors to act in the best interests of the corporation. However, if the directors act in good faith in declaring a dividend, the courts have been reluctant to interfere with the business decision of the board to pay dividends.
(ii) Declaring the Dividend
Before declaring a dividend, directors should review the corporation's financial statements and receive confirmation from someone on whom they can reasonably rely, such as the corporation's chief financial officer, that there are no reasonable grounds for believing that the solvency tests will not be met. In relying on the advice of the corporation's financial officers, the board should question the officers to confirm that appropriate assumptions have been made about the realizable value of the corporation's assets. The nature of these assumptions is described in Part IV under "Corporate Solvency Tests". In some circumstances, the directors may wish to obtain a certificate from the chief financial officer or, in unusual circumstances, receive outside advice. The resolution declaring the dividend or the minutes of the board meeting should record the fact that the directors took the appropriate steps to address the solvency tests.
If the dividend is being paid in shares or property, rather than cash, the directors must determine the value of the shares or property. While this does in some circumstances pose practical problems, the directors must have this information in order to be satisfied that the solvency tests are met.

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2. Disclosure Obligations
One of the most significant implications for corporations which access the public markets is that they become subject to various ongoing disclosure obligations. The prospectus disclosure requirements are intended to ensure that disclosure of all material facts is made to investors at the time a public offering is made. There is also a need for corporations to make ongoing disclosure of their affairs on a timely basis so that investors who participate in the secondary trading markets have appropriate information. To ensure a fair and accurate trading market, investors must have equal and timely access to material information concerning a corporation. As a result, public companies are subject to a collection of ongoing disclosure and reporting obligations which are intended to ensure delivery of this information to the public markets whether or not a corporation is currently undertaking a financing.
The TSE established a committee in the summer of 1994; expected to report in the summer of 1995, to examine possible changes to securities laws governing continuous disclosure by public companies. In particular, the committee will consider whether statutory civil liability should be imposed upon directors with respect to corporations' obligations to ensure that there is timely and continuous disclosure. If enacted, this would provide a statutory basis to enable shareholders to sue for damages stemming from inaccurate disclosure. The committee's creation followed the release of the TSE Corporate Governance Committee's draft report which recommended that Canada's securities administrators examine this issue.
(a) Timely Disclosure
Most of the ongoing information which is disclosed to the public marketplace is released or distributed on a periodic basis, for example, through the filing of annual or interim financial results. However, material developments may occur more frequently and one of the key aspects of the public disclosure system is a set of rules that ensure that these material developments are provided to investors on a timely basis.
Public corporations are required to disclose immediately any material change in the corporation's business, operations or capital, that would reasonably be expected to have a significant effect on the market price or value of any of the corporation's securities. If disclosure of a material change would be unduly detrimental to the interests of the corporation, the corporation may be able to file the information on a confidential basis, although this option is used infrequently.
A further timely disclosure requirement is found in National Policy 40 issued by the Canadian Securities Administrators. This policy requires timely disclosure of "material information". The concept of "material information" can be somewhat broader than "material change". For the purposes of National Policy 40, "material information" means:
...any information relating to the business and affairs of an issuer that results in or would reasonably be expected to result in a significant change in the market price or value of any of the issuer's securities.
National Policy 40 provides a detailed list of developments that may be considered material information, but it is ultimately the responsibility of the issuer to determine which information is material in the context of its own affairs. The policy recommends media releases of material information as soon as it is available, but recognizes the need for confidentiality where immediate release of the information would be unduly detrimental to the issuer.
The stock exchanges also impose similar timely disclosure requirements. The Toronto Stock Exchange, for example, requires a listed corporation to issue and file a press release disclosing material information immediately upon the information becoming known to management or upon the information becoming material to the

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corporation, unless immediate release of information would be unduly detrimental to it.
Determining when a matter has developed or crystallized to a point which requires disclosure is often a difficult judgment and one on which parties can reasonably disagree. It is also a matter that can be second guessed in hindsight. Accordingly, some corporations have a policy that where there is significant doubt, such doubt should be resolved in favour of disclosure.
(b) Announcing a Transaction
One of the thorniest questions facing a public company is when it must disclose a major transaction. By the time a transaction is announced, there have often been months of discussions and negotiations. While cognizant of the timely disclosure obligations, a corporation and its directors will nevertheless be concerned about disclosing a potential transaction too soon. Premature disclosure may have a negative impact on the corporation's bargaining position during negotiations or on the corporation's position if the transaction does not proceed. Further, it may create undue expectations or uncertainty in the marketplace. Securities regulators have been critical not only of disclosure that is made too late, but also disclosure that is made too early.
A threshold question is what role or responsibilities the directors have in making timely disclosures. While it is clear that disclosure is the corporation's responsibility and, therefore, at least indirectly the directors' responsibility, securities regulators have suggested a more direct responsibility and involvement by board members in the process. In Standard Trustco, the Ontario Securities Commission indicated that in some circumstances directors should be involved in reviewing the actual announcement. While boards are generally aware of the issues and decisions relating to timing, the actual timing of a release and wording of the announcement is normally more directly the responsibility of senior management.
Three general principles provide the conceptual framework for determining when disclosure is required. First, material information may not be disclosed selectively. All investors should have simultaneous access to material information relating to publicly-traded companies. Second, the legitimate corporate interest in confidentiality may be considered. Corporations must be allowed to pursue material transactions without disclosing the transaction until an appropriate point in time. Finally, while late disclosure of material information may put certain investors at a disadvantage, damage to the marketplace may also occur if the announcement of material information is premature. For this reason, securities regulators have taken the position that if a public corporation announces an intent to proceed with a transaction which could result in a material change, that announcement implies a present willingness and ability to carry out that intent.
In brief, a transaction typically need not be disclosed until such time as the corporation is in a position to proceed with it. If the transaction requires the agreement of another party, disclosure will not generally be necessary until the parties have entered into a binding agreement or have at least reached agreement on the principal terms. On the other hand, if the matter is one which is completely within the control of the corporation, such as a commitment to a major new product or a plant closing, disclosure will usually be appropriate once the board has made the decision to proceed. Disclosure may also be appropriate if senior management has made the decision to proceed, if it reasonably expects the concurrence of the board of directors in this decision.
There are various factors which can further complicate the disclosure issue. For example, different parties to a transaction may have different thresholds for materiality. As a consequence, the actual timing of a disclosure may not be completely within the control of the corporation. Another complication is what to do when a matter has leaked prematurely into the public market and reporters, regulators or others are

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asking for comment on the matter. In these circumstances, the corporation must be very careful. In some instances, it may be satisfactory to state that there are no current developments which require disclosure. In other cases, a single "no comment" may be more appropriate, or it may be necessary to make much fuller disclosure, even though the corporation or other parties to a potential transaction may prefer not to make any disclosure which is not strictly required by law.
As a further principle, until public disclosure is made, the information relating to material matters should be disseminated only on a "need to know" basis and only to those who are in a position to treat it as confidential.
(c) Financial Statements
Corporate statutes typically require companies to issue audited financial statements on an annual basis and distribute them to their shareholders. These requirements have been supplemented by securities rules which require the issuance of interim unaudited financial statements on a quarterly basis.
Public companies must have in place procedures for the preparation and release of these interim and annual financial statements. The role of the board of directors in this regard, in particular through the audit committee, is to ensure not only that the financial statements are properly prepared, but also that the process for preparation and release of the financial statements is adequate.
(d) Annual Information Form ("AIF")
When the short form prospectus system was introduced, issuers who chose to access this system were required to prepare an annual disclosure document to provide a base of prospectus level disclosure of the issuer and its business. This document, known as the Annual Information Form or "AIF", is now an annual requirement for virtually all reporting issuers. The concept, and its form, borrows to a significant extent from a comparable U.S. annual filing requirement known as a Form 10-K. The underlying principle is that, quite apart from the conventional annual report, all public issuers should prepare at least an annual update on the disclosure of their business.
For those issuers who use the short form prospectus system, the AIF forms a key element of the prospectus disclosure. As discussed, once a short form prospectus financing occurs, the AIF becomes incorporated by reference into the short form prospectus. When this occurs, directors have the potential for personal statutory civil liability in relation to this document because it is deemed to form part of a prospectus. As a result, it is essential for the directors to ensure that the AIF is prepared in a way that ensures its accuracy. It is particularly important for the directors to satisfy themselves that the corporation's procedures include steps to comply with the due diligence process discussed above, on which the directors will base their defence to any claim.
(e) Management Discussion
and Analysis ("MD&A")
Another development in the area of continuous disclosure which securities regulators in Canada have adopted from the United States is the introduction of a management discussion and analysis requirement. The MD&A is a narrative supplement to the annual financial statements of a corporation. It is specifically intended to allow investors to see the financial position of the corporation "through the eyes of management". It has become one of the most significant ongoing disclosure elements and has been the focus of an ongoing review by Canadian securities regulators. While they do not routinely review in a substantive way the annual and other periodic filings of reporting corporations the securities regulators do review the MD&A disclosure of Canadian issuers. The Ontario Securities Commission has issued annual reports on their assessment of issuers' compliance with these requirements. For example, the reports have suggested improvements for MD&A discussions of future environmental liabilities and financial

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instruments or derivatives. As a result, there has been particular focus on the development and extent of the MD&A. Its importance has also been highlighted in the United States, where the Securities and Exchange Commission has undertaken enforcement action against U.S. reporting issuers which the Securities and Exchange Commission felt had not adequately complied with the MD&A disclosure requirements. The Ontario Securities Commission has made it clear that it would be prepared to take comparable action in circumstances where it believes corporations have not adequately complied with the MD&A requirements, and has now begun to do so. For example, it required Maple Leaf Gardens, Limited to issue and distribute to its shareholders a rewritten MD&A because of compliance deficiencies in its ongoing MD&A.
One of the aspects of the MD&A requirement that differs from the traditional approach to disclosure in the public markets is that, in addition to an analysis of historical information, the MD&A mandates certain prospective information. The issuer must consider whether there are any known trends, uncertainties and risks which could be material. As a result, there is a forward looking element which is to be considered in preparing part of the ongoing publicly-filed material. This can be a particularly difficult judgment. Furthermore, it is often easy to judge such disclosure, or a lack of it, in hindsight. The Ontario Securities Commission has recently observed that the risk and uncertainties part of the MD&A often lacks depth. Risks and uncertainties can relate to industry or price competition, changing technology, foreign exchange rates, interest rates, raw material costs, increased environmental regulation, the effects of NAFTA or similar treaties and possible negative outcomes in litigation or tax reassessments.
While the material contained in the MD&A is described as a "management" discussion and analysis, the board must also be satisfied that it adequately meets the level of disclosure imposed on the corporation.

(f) Executive Compensation
Recently, the securities and corporate rules have required public companies to make expanded disclosure about executive compensation.
The most significant change was to move from a system which permitted disclosure on an aggregate basis to one which requires individual disclosure for the five highest paid executive officers. The rules attempt to ensure that information be provided in a "plan, concise and understandable manner". Much of the information must now be presented in tabular form.
The compensation committee (or the whole board if there is no committee) is required to include a report in information circulars and annual filings that describes its policies and basis for determining the compensation paid to executive officers and the relationship of the company's performance to the compensation paid to the CEO.
The rules require inclusion of a line graph which compares the shareholder returns over the past five financial years on each class of publicly-traded equity securities issued by the company, with the return of a broad equity market index that includes issuers whose securities are traded on the same exchange or which have comparable market capitalizations. The purpose of the performance graph is to provide shareholders with information on how well the issuer has performed in its industry as a context in which to assess the compensation paid to the executive officers.
This additional disclosure has increased the prominence and disclosure of the role of the board in the compensation process and attempts to tie compensation to performance, while appropriate in general terms, can be difficult in practice.
Staff of the Ontario Securities Commission have recently released a report dealing, in part, with disclosure of executive compensation and identified the following areas as needing

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improvement: descriptions of reasons for payment of bonuses, performance targets and the relationship of executive compensation to those targets, the relationship between the compensation committee and the board of directors, in particular, the process and interaction of these two entities in the compensation decision process and a description ofthe reasons for selecting a particular peer group when establishing relative compensation levels. Staff also noted that the report should describe the process undertaken by the compensation committee and/or the board of directors, and should specifically identify the factors and the weight given to those factors in determining executive compensation.
(g) Proxy Rules
A key element of the corporate governance process as it relates to shareholders is the requirement that public companies solicit proxies, or voting instructions, from their shareholders whenever a shareholders' meeting is to be held. These requirements are intended to help shareholders participate in the shareholder approval process. In addition to a requirement to solicit a proxy from each shareholder, corporations must provide shareholders with a management proxy circular which sets out in adequate detail the issues to be decided at the meeting. For most annual meetings, the information is fairly routine and relates primarily to issues such as the election of directors and remuneration of officers. However, for more complex matters which are dealt with at special meetings of shareholders, the corporation can be required to include in the management proxy circular very detailed disclosure about a transaction and its implications for the corporation. In those circumstances, the management proxy circular often resembles, and in effect is a substitute for, a prospectus. While there may not be specific statutory civil liability for the directors in relation to this document, they nonetheless should be satisfied that the disclosure in the document is sufficient to enable shareholders to make a reasoned judgment on the matter.

A related point is the need for the corporation to have proper procedures in place for conducting meetings of shareholders that give shareholders an appropriate opportunity to express their views. The opportunities available for shareholders to express their views is discussed in Part II.
(h) Insider Reporting and Trading
Directors are included in the category of "insiders" of a public company. This means they are considered part of the group of people that would reasonably be expected to have access to material information about a public company. In order to protect the integrity of the marketplace and ensure that the secondary markets are based on the principle of equal access to material information, various rules are imposed on insiders.
The principal elements are a requirement for insiders to report their holdings and trades in securities and separate civil liability if they trade on, or inform others of, material information before the information is generally disclosed to the public. This is dealt with in greater detail in Part IV. The reporting requirement effectively provides the public and the securities regulators with a method of assessing whether or not a breach of the insider trading rules has taken place. It also gives investors an opportunity to see whether (and which) insiders are buying or selling the securities of the corporation.
The reporting requirement is detailed and complex, both because it applies to a broad range of securities and because filings are often required in more than one jurisdiction. The area is viewed as a particularly significant requirement by regulators and failure to file in an accurate and timely way can be the subject of public censure or administrative action by the securities regulators. As a result, it is essential that directors fully understand the extent of the reporting obligation and ensure that they comply with it in a complete and timely fashion. The typical practice for larger or more established public companies is for the corporate secretary or inside counsel to have a memorandum

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prepared for directors which outlines the reporting responsibilities and assists and outlines where and when material must be filed. It is important that directors review, understand and comply with these requirements on a timely basis.
To comply with the prohibition on improper trading, a director must not buy or sell securities at a time when material information concerning the corporation has not been generally disclosed. In addition to actually being disclosed, the information must have been reasonably disseminated. As a result, it is not appropriate for insiders to trade immediately following the release of material information. It is necessary for the insider to allow some appropriate period of time to elapse before entering the market. While this period will vary, the time period is generally considered to be at least 24 hours after the press release was issued, and may be up to a week if the information is not picked up and disseminated to the public through the news media.
In addition to a prohibition on improper trading, there also exists a prohibition on insiders informing others of material undisclosed information. There is an exception if it is considered to be in the necessary course of business to do so. For example, directors routinely inform outside advisors of the nature of a transaction so they can be provided with expert advice and assistance. The persons receiving the information are themselves subject to prohibitions on trading.
3. Dealing With a Controlling Shareholder
Most directors of Canadian public corporations are generally familiar with the procedures involved in so-called related party transactions. This familiarity is a byproduct of the shareholder profile of the typical Canadian public corporation � a public corporation with a controlling or significant shareholder. There are some widely-held corporations in Canada, but they constitute a small minority among Canadian public corporations. This characteristic of Canadian public corporations is in contrast to the shareholding profile of United States public corporations, the majority of which are widely held. Directors must understand their relationship, and that of the corporation, to the controlling shareholder. This is relevant on a day to-day basis and particularly when the corporation proposes to enter into a transaction with its controlling shareholder. These topics are discussed below. The issues facing directors who are in positions of potential conflict when they act, for example, as directors for both the corporation and its controlling shareholder are discussed in Part II.
(a) Ongoing Relationship with the Controlling Shareholder
As a practical matter, the economic interest of a controlling shareholder in a corporation generally results in the shareholder taking a particular interest, and having a significant involvement, in the operations of the corporation. This relationship will be reflected in a variety of ways, in particular through representation on the board of directors. It is also generally in the corporation's interest to maintain a strong relationship with its controlling shareholder for many reasons. This relationship may, for example, enable the corporation to assess the prospects for the success of corporate initiatives.
The board must, however, balance the desirability of a good relationship with the corporation's controlling shareholder with its obligation not to treat the controlling shareholder more favourably than other shareholders. A key element in the relationship is managing the information provided to the controlling shareholder. As a general matter, the board must bear in mind that it is inappropriate to provide information to one shareholder or group of shareholders which is not being provided to all shareholders. However, the corporation may, in its best interests, discuss initiatives with the controlling shareholder and in the course of these discussions, necessarily communicate confidential information. The corporation may do this, provided it is satisfied that the information will not be misused.

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(b) Transactions Between the Corporation and the Controlling Shareholder
In Canada, any transaction, such as an acquisition, financing, change of control or reorganization, is classified as a related party transaction if the significant shareholder is a party to the transaction. It can also be a "related party transaction" if the significant shareholder is affected differently than public shareholders or has had a different and more directing role in the development of the transaction from that of public shareholders. Securities regulators in Canada provide certain procedural requirements and guidelines for a public corporation proposing to enter into a related party transaction.
The corporate statutes do not provide specific direction to the directors on how to deal with these transactions, apart from providing a procedure for directors with a conflict of interest. Specific procedures have, however, been developed under the securities laws which reflect a large measure of business common sense, some judge-made law and the concern of Canadian securities regulators for fair treatment of the investing public. The procedures are designed not only to achieve substantive fairness, but also to be perceived by the investing public to be fair.
For the reasons discussed above, related party transactions are not uncommon in Canada. Often the transaction is proposed by the significant shareholder who may want to transfer an asset to the corporation, acquire securities of the company, cause the corporation to reorganize so that the shareholder's interest is held differently or enter into a joint venture with the corporation in a new business. In these circumstances, the board of the corporation must ensure that the terms of the transaction are comparable to the terms which would result from an arm's length negotiation. Achieving this objective will generally require the board to appoint a committee of members who do not have any material interest in the transaction and who can objectively judge whether the transaction is in the best interests of the corporation. The fact that a director is recruited and nominated by the significant shareholder does not in itself disqualify that director from participating on the committee. However, the director's obligation is to judge what is in the best interests of the corporation. Indeed, it is often the case that the entire board of the corporation may have been recruited by the significant shareholder.
Often the responsibility for judging the fairness of the transaction is fully delegated or assigned to a special committee of the board with simply an obligation to keep the full board informed. This procedure may be followed because the full board is not in a position to judge the transaction objectively as a result of the involvement of a number of its members in the transaction. The committee may retain its own legal counsel and financial and other experts. Legal experts assist the committee with the process and financial experts may provide independent evidence to support the committee's judgment such as through a valuation of an asset involved in the transaction or an assessment of the fairness of the transaction "from a financial point of view". The judgment the committee is obliged to exercise does not extend solely to the financial fairness of the transaction. The committee is obliged as well to take into account other strategic considerations in judging the transaction.
Ontario Securities Commission Policy 9.1 plays a significant role in the governance procedures applicable to related party transactions. There has always been a debate about the Commission's jurisdiction to prescribe procedures which might normally be considered to be pure corporate law issues. The Commission's venture into issues of corporate governance reflects its frustration with the conduct of some closely-held public corporations and its perception that judge-made law in this area was developing at a slow pace. Although recent judicial decisions relating to the power to issue policy statements have put limits on the Commission's jurisdiction in this area, those affected continue to conclude that settlement in a timely manner is the more prudent course.

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Policy 9.1 identifies a common theme in related party transactions, issuer bids, insider bids and going private transactions: the related party issuer or insider may have, or be perceived to have, an advantage in terms of access to information as well as an ability to influence the decision making process in entering into a transaction with the corporation. Policy 9.1 prescribes certain requirements depending upon the transaction, including an independent valuation, formation of a special committee of the board, canvassing the directors' views as to the fairness of a transaction, as well as minority shareholder approval.
Each type of related party transaction will raise its own particular corporate governance issues. Transactions such as issuer bids and insider bids must be accompanied by an independent valuation, a measure designed to neutralize the information advantage of the issuer and insider. Certain valuations which may have been prepared prior to the transaction, whether or not in relation to the transaction, must also be disclosed.
In designing the governance approach appropriate to a particular transaction, directors should first determine which steps they believe are necessary to achieve substantive fairness and to be perceived as having effectively represented the interests of the shareholders as a whole. This determination should then be analyzed in light of the requirements of Policy 9.1. Policy 9.1 has attempted to codify a number of requirements, such as the meaning of "related party transaction", "independent director" and "independent valuator". In some instances, directors may want to go beyond these requirements and in others they may believe that Policy 9.1 prescribes requirements which are inappropriate to the transaction and decide to seek exemptions.
The legal advisor on a transaction should advise the board on the requirements of any of the stock exchanges on which the corporation is listed, although compliance with Policy 9.1 will generally result in compliance with the stock exchange requirements.
4. Significant Transactions
(a) Take-over Bids
A common form of take-over bid is one in which the controlling or significant shareholder either offers to acquire more shares or one in which that shareholder offers to sell its shares to a third party, who then offers to acquire the remaining shares from the public shareholders. There can also be a bid for a widely-held company, but this is generally a less frequent occurrence in Canada.
Often, the significant shareholder will not agree to a sale until it is satisfied that all potentially interested parties have had an opportunity to bid. To facilitate the sale process, the selling shareholder will usually want to provide interested parties with access to information concerning the corporation and its management, which will require the board of the target corporation to consider a number of issues.
The first issue which the corporation's directors face is whether the corporation is "in play" and whether it should publicly disclose its knowledge that the corporation is "in play". This is a difficult judgment. The directors must balance the interest of the selling shareholder in preventing the market price of the target corporation's shares from rising prematurely to reflect a transaction not yet negotiated (thereby discouraging other bidders) against the interest of the corporation in informing its public shareholders of the potential sale.
The second issue is the desire of the selling shareholder to allow interested purchasers to "kick the corporation's tires". If the corporation provides sensitive information to potential purchasers, this must be done under the protection of a confidentiality agreement which protects the corporation from misuse of the information. Directors of the corporation who are also directors or officers of the selling shareholder must be careful not to be a source of information about the corporation if this would be a breach of their duty to the corporation.

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Another issue normally faced by the corporation's directors is their advice to the corporation's shareholders on the fairness of the offer. If the offer is made to the controlling shareholder but is not extended to the public shareholders, the board's role will be limited. Indeed, in these circumstances, most, if not all, of the directors, will resign to enable the new controlling shareholder to constitute its own board.
If the offer is extended to the public shareholders (securities legislation precludes a sale of the significant shareholder's position at more than a 15% premium to market) the board of the corporation will be expected to recommend acceptance or rejection of the offer. The recommendation will generally be supported by the opinion of a financial advisor engaged by the corporation's board. This will be a "fairness" or "unfairness" opinion from a financial point of view. A favourable recommendation from the corporation's board is of some value to the acquiror and provides some scope for negotiation by the board of the target corporation and the opportunity to move the offering price into the corporation's fairness range. The leverage of the target corporation's board increases with the desire of the acquiror to acquire 100% of the corporation's shares. The development of the board's response to the offer will generally be assumed by a committee of the board made up of directors other than those interested in the success of the offer through a relationship with the controlling shareholder.
If the purchase price for the control or significant block of shares is at a premium to market (more than 15% over market) the offeror must make the offer to all shareholders at the same time. The offeror may not take up and pay for any shares unless all shares deposited, including the control or significant block, are taken up and paid for at the same time. If more shares are tendered than the offeror is willing to acquire, the shares which are tendered must be taken up proportionately to the number of shares deposited by each shareholder.
Directors of a widely-held corporation which is the target of an unsolicited take-over bid have more options in responding than directors of a closely-held corporation who are informed by its significant shareholder that it has agreed to sell its shares of the corporation. In the widely-held context, the target corporation's directors can create a legal framework which effectively obliges the acquiror to negotiate with the directors and seek the agreement of the directors before the acquiror may proceed to acquire control.
Directors of a widely-held corporation will not normally have much notice that the corporation is to be the subject of a take-over bid. Accordingly, they should generally try to establish a legal framework or plan in advance of any bid, to enable the corporation to respond efficiently and effectively to a bid.
A commonly adopted element of a legal framework is a shareholder rights plan or so-called "poison pill". It is a device which many widely-held corporations have adopted prior to a bid being made for the corporation's shares. The device is a contract between the corporation and a trustee for the shareholders in which the corporation agrees to issue shares to all holders, except to the bidder, at a substantial discount if the bidder acquires shares in excess of a specified threshold � usually 20%. A bidder, therefore, faces the prospect of significant dilution should it proceed with its bid without the plan having been removed. The directors of the target corporation are normally given the power under the terms of the plan to terminate the plan once they are satisfied that it has fulfilled its purpose.
The discriminatory aspect of the rights plan against the bidder has provided the basis for a lively debate among lawyers about the legality of such plans. However, lawyers are generally comfortable with, at the very least, "a better view" opinion which in many circumstances has been sufficient for the directors to adopt the plan. The securities commissions expect a rights plan, which typically becomes effective when adopted by the board, to be confirmed by shareholders within a reasonable period, usually a matter of months. It is possible for a board of the target corporation to adopt a plan in response to a bid, provided the board takes the plan to the shareholders as soon as reasonably possible. Such a strategy gives the

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board more time than would be available under the securities laws to consider and pursue its options. A board adopting a plan in response to a bid may well find itself before a securities commission justifying its action. Indeed the Ontario Securities Commission has been called upon on more than one occasion to suspend a rights plan in order to allow a take-over bid to proceed (notably, in connection with the 1994 take-over bids for Lac Minerals Ltd. and Regal Greetings & Gifts Inc.). The Commission has shown particular concern not to usurp the role of the board of directors of a target corporation that is actively pursuing options with respect to the best way to maximize shareholder value. But it has, nonetheless, made clear that if a rights plan has fulfilled its purpose in facilitating the pursuit of those options, then in appropriate cases the Commission will intervene in order to allow take-over bids to proceed to shareholders.
While in the closely-held situation the directors' response to a bid is effectively limited to commenting on the value of a bid, in the widely-held situation the directors have a broader range of responses available. The target directors will first make a judgment whether the bid has put the company "in play", that is, whether a change of control is likely. Most bids for widely-held corporations will have this effect, but this change of status is not automatic � particularly if the target has a rights plan in place; for example, the conditions in the bid may not be achievable in the judgment of the board of the target corporation. The board may also conclude that the value of the consideration offered is not sufficient and, therefore, refuse even to open negotiations with the offeror. Taking a hard line with an offeror will attract the attention of, among others, the securities regulators who generally favour giving the shareholders the opportunity to reject an inadequate offer, rather than having the directors effectively preclude the shareholders from judging the offer.
The judgment of whether the target corporation is in play will assist the target board in sorting out its priorities. If the board believes that the corporation is in play, the board's attention should shift from the corporation to the shareholders and the board should undertake a strategy designed to increase the value to be realized by shareholders. Normally this will involve engaging an investment banker to manage the sale process. The sale process will normally require more than the minimum time an offeror is obligated to provide the offeree shareholders to accept the offer. A rights plan will generally serve the purpose of extending the time an offeror has to keep its offer open and afford the board of the target corporation the opportunity to ensure that if a change of control is going to occur it occurs on the most favourable terms. The structure of Canadian rights plans has evolved rapidly since their introduction in Canada in 1988. There are now a variety of differently structured plans that are suited to different contexts. In addition, institutional shareholders and their representatives have been active in commenting on, and obtaining changes to proposed plans. Directors of companies proposing to adopt a rights plan will need to be sensitive to the kind of plan that is appropriate for their company given the context in which it proposes to adopt that plan.
Most directors will be aware of the "just say no" response to a take-over bid. In this response the board of the target corporation takes steps to ensure that the bid will not succeed. Such a response might involve, for example, refusing to terminate a shareholders rights plan in the face of an offer. The ability of the board of a Canadian company to adopt such a strate gy has not been tested by the securities commissions or the courts. A board undertaking such a strategy would do so on the basis that the change of control contemplated by the offer is not in the best interests of the corporation, that is, the board has decided that the corporation should not go into play and that the board must act to protect the corporation's best interests. Such circumstances would include a situation where the corporation is in the midst of a business plan which the offeror would terminate or unwind.
The spotlight will be focused on the board of the target corporation, particularly if an offer to the corporation's public shareholders is involved. Inevitably one or more of the target constituencies, for example, the public shareholders, the failed bidder or the institutional shareholders, will be disappointed by the outcome of the process

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Environmental concerns are inherent in certain industries. Directors should understand the environmental issues relevant to the corporation they serve. They should also be aware of what others in their industry are doing to prevent environmental problems. Before they join the board, directors should ensure that they are aware of the environmental issues facing the corporation and the procedures in place to deal with those issues. They should keep themselves informed of such issues confronting the corporation as they evolve.
The board should seek input on environmental matters. It should look to its legal advisors to outline the corporation's responsibilities. Second, it should look to environmental experts to advise on the state of the corporation's compliance with those responsibilities and about what should be done to minimize the risk of environmental concerns. Third, it should look to management to advise about the ongoing compliance with legal requirements and the corporation's own internal systems as well as about the performance and adequacy of those systems. Both as a matter of internal record keeping and to support a defence of due diligence in the event that the corporation or a director is charged under an environmental statute, the deliberations of the board and its commitment to good environmental practices should be reflected in the minutes of board meetings.
(a) Ongoing Compliance
Many corporations have developed environmental management systems ("EMS") to deal with environmental matters. To ensure that an EMS is effective, directors must instruct corporate officers regarding their responsibilities in the system and ensure that they report back periodically to the board on the operation of the system and more frequently if specific environmental concerns are identified. As discussed in Part I, directors are justified in placing reasonable reliance on reports provided to them by corporate officers, consultants, counsel or other informed parties. However, this may not relieve directors of responsibility. If they become aware of a specific environmental concern or if they recognize that the EMS is not working effectively, they must take corrective action immediately.
In general, an effective EMS will ensure that:
€ those responsible for operating and supervising corporate activities that may affect the environment are educated, trained and monitored on an ongoing basis;
€ problems and potential risks are identified on an ongoing basis;
€ such problems and risks are communicated to those responsible so that they can be dealt with; and
€ any problems and risks are promptly and adequately addressed.
The board should be advised regularly of the progress made on any remedial action underway and on the results of audits of the environmental programs. In order to discharge their duties, directors must review environmental compliance reports and satisfy themselves that they can rely on those reports. They must be satisfied that the officers are promptly addressing environmental concerns brought to their attention by government agencies or other concerned parties. If a board fails to monitor the corporation's reporting structure, it runs a serious risk of a court imposing liability on the basis that the failure to comply with its own internal structure "permitted" a breach of applicable environmental legislation. Moreover, a director's lack of knowledge of a contravention by the corporation will not be a defence unless the board has reasonable systems in place to ensure that directors are informed of possible contraventions. The establishment and operation of appropriate systems will support an argument on behalf of the directors that they took "all reasonable care" to prevent the corporation from causing or permitting environmental damage.
The frequency of reports to the board regarding environmental matters will depend on the extent to which the corporation's operations are

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environmentally sensitive. Reports should be made regularly and should comment on the effectiveness of the corporation's EMS. Special reports should be made whenever there is a significant or unusual occurrence.
Information reported to the board should be presented in a "closed loop". That means that information should not be presented in a way which requires the board to consent or agree to a particular course of conduct unless the particular issue is one which requires board agreement. Instead, at the same time as information is presented regarding a concern, solutions should also be presented so that board members are satisfied that the concern is being adequately addressed. Follow-up reports should also be made to ensure that the board is aware that the solutions which were implemented are effective.
In industries where environmental issues are significant, it is advisable for a committee of the board to be struck and specifically designated to devote the necessary attention to the issues. Where a committee is established, its mandate should be specific. Since all of the directors are subject to potential liability, the full board should be advised on a regular basis of the status of the corporation's environmental programs. The role of an environmental committee should be to advise and monitor, to report back to the full board and to recommend to it systems and measures that not only raise awareness of environmental issues at the board level and throughout the corporation, but that reinforce the commitment of the board to environmental safety and compliance as an element of all decisions of the board.
An environmental committee of the board should, if possible, be composed of directors with knowledge, expertise or experience in the environmental area and should include outside directors. Such a committee can often better handle difficult environmental issues while keeping fellow board members informed of the nature of its deliberations. Further, the establishment of such a committee may be seen by courts and concerned members of the public as a commitment by the corporation that environmental matters receive the utmost care and attention. Directors on an environmental committee will be expected to have more detailed knowledge of environmental risks and effectively greater responsibility for ensuring that the EMS is effective.
As part of the corporation's commitment to environmental compliance, the board or the environmental committee should consider commissioning an environmental audit program to determine the nature of existing problems, if any, the adequacy of the systems to ensure compliance and the extent of compliance. An environmental audit may take different forms. The audit should have a specific mandate which is well understood both by the board and the auditor and should result in a written report presented to the board for its consideration. The board will often invite the environmental auditor to attend a meeting of the environmental committee or the full board to answer specific questions arising from the report. The audit report and deliberations of the board should lead to the development of an action planfor any necessary remedial action.
The board must be satisfied that the corporation has committed adequate resources to the environmental program and that responsibility for the program has been assigned to one or more responsible members of management who have the requisite authority to ensure that the program is being implemented. These individuals will be responsible for the day-to-day application of practices and procedures.
To the extent that any member of the board is actively involved in the day-to-day operations and, in particular, with aspects of the operations which would � or reasonably should � make them aware of environmental issues, the potential liability of that director will be significantly increased.
(b) Specific Occurrences
Notwithstanding any ongoing systems, the corporate officers responsible for environmental matters must be instructed to report any substantial non-compliance by the corporation to the board of directors in a timely manner. Each director

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should react immediately to ensure that the appropriate action is being taken and should not simply assume management or other directors will ensure that the matter is being addressed. If an order is made by environmental authorities, the board must ensure, in consultation with legal counsel and environmental advisors, that the corporation takes the necessary action to comply with the order. Failure to respond promptly to any breach of an environmental statute or to the corporation's own environmental standards established to comply with environmental requirements could also lead a court to conclude that the directors had permitted a breach or the continuation of a breach.
(c) Acquiring an Interest in Real Estate
Ongoing compliance with respect to any property owned or leased by the corporation can be a major concern for most corporations and their boards. However, environmental liability must also be considered whenever the corporation acquires an interest in real estate. A corporation may acquire an interest in real estate in a number of ways. It may acquire the property directly, it may lease the property from the owner or sublease it from another lessee, or it may make an investment in the property. This may result in the corporation, and to varying degrees the directors, incurring liability under environmental legislation.
When considering the acquisition of an interest in real estate, the directors should require management to report to them on the current and prior uses of that property. In some circumstances it may be prudent to have an environmental audit conducted to assess environmental concerns associated with the property. Representations and warranties with respect to the property should be scrutinized carefully to ensure that the board understands the nature of any liabilities that the corporation is assuming.
6. Facing Insolvency
A corporation is insolvent when it is unable to pay its liabilities as they come due. Insolvency does not normally occur unexpectedly and there should, therefore, be time for the board of directors to address the problem as it develops. In fact, however, directors often do not recognize the signs of impending insolvency until it is too late. This happens for a number of reasons. First, cash flow difficulties may not be readily apparent from the financial statements. Second, it is often difficult for both management and the board to come to grips with the fact that the corporation's problems have progressed to a level such that the term "insolvency" becomes appropriate.
When a corporation becomes insolvent several courses of action are possible. In Canada, the corporation may continue to operate with the indulgence of its creditors for a period of time. This is different from some jurisdictions outside of Canada, where a corporation which is insolvent must stop carrying on business to prevent it from incurring further liabilities. Alternatively, the corporation's creditors may require the corporation to restructure its operations or to divest certain assetsto generate additional cash, under either a private agreement or under the restructuring provisions of the Bankruptcy and Insolvency Act or the Companies' Creditors Arrangement Act. Finally, secured creditors may take steps to have a receiver appointed, with a view to realizing on and liquidating assets. Ultimately, the corporation may be declared bankrupt.
The insolvency of a corporation is of concern to directors on three levels. First, directors will be concerned about the role they should play in guiding the corporation back to solvency. Second, in fulfilling this role directors may wonder whether their accountability shifts from the corporation to the creditors. Finally, in view of the level of publicity surrounding the liability of directors of insolvent companies in the early 1990's, directors will be concerned about their personal exposure when the corporation becomes insolvent.
(a) The Role of the Board
In the context of a restructuring to address an insolvency, the role of the board is to ensure that the appropriate management team is in place and that management is developing and

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implementing a carefully thought out plan of action. The board also has a responsibility to authorize the course of action which the directors view as being in the best interests of the corporation. In order for the board to fulfill its role most effectively, it should consider appointing a special committee. The committee should be composed of outside directors and the president or chief executive officer and should monitor closely management's decisions about the ongoing operation of the business and any restructuring steps.
One of the first tasks for the board, or its special committee, will be to determine whether any changes to the management team are required. A new management group which could be viewed as a "work-out team" may have more credibility with the creditors since it will not be associated with the decisions and policies which led to the insolvency.
Once it is determined who will be part of the management team during the corporation's recovery phase, a clear course of action for dealing with the issues must be developed and implemented. It is usually the role of management, rather than the board, to develop a plan for dealing with the insolvency, including the way in which the corporation will deal with its bankers and other creditors. The approval of the board of directors will, of course, be necessary before any major decision on the future of the corporation may proceed. The board, or its special committee should consider engaging qualified outside financial consulting services to advise it in its deliberations.
While discussions with the creditors are proceeding, the directors should monitor the progress of those discussions, but typically will not be involved in the day-to-day discussions. Board members may be called upon to participate in certain strategic meetings.
(b) To Whom Directors Owe Their Duty
The second area of concern for the directors is where their allegiances lie in a situation of insolvency. In Canada, it is clear that the directors owe no duty to the creditors of the corporation, even if the corporation is insolvent. This is again contrary to developments in other countries. In some jurisdictions, the courts have held that directors have a duty to consider and act in the best interests of creditors where the corporation becomes insolvent or nears insolvency. The increased leverage which creditors may have over the corporation may, however, align the interests of the corporation quite closely with the interests of the creditors. If a receiver-manager is appointed by one or more creditors, the responsibilities and powers of the directors will be suspended until the receiver-manager is discharged. Until that time, the receiver-manager will have the power to carry on the business of the corporation in order to protect the security interest of those creditors on whose behalf it is appointed. The appointment of a trustee in bankruptcy usually signals the end of the corporation.
While the duties of the directors do not change upon the insolvency of the corporation, directors should be particularly conscious of the actions they take when the financial stability of the corporation is in question, both for the best interests of the corporation and due to the likelihood that the actions of the directors may be challenged if a receiver is appointed. This will be the case with respect to actions which have the result of moving assets out of the corporation, particularly into the hands of the shareholders. For example, any dividends paid, shares redeemed or financial assistance given prior to the corporation's insolvency may be reviewed very carefully by the receiver to ensure that such action did not precipitate the insolvency. Where the receiver is able to demonstrate that such actions did precipitate insolvency, the receiver will have the authority to bring an action to hold the directors personally liable to return the expended funds to the corporation. Similarly, any payment made to a creditor may be scrutinized to determine whether it constituted a fraudulent preference. Bankruptcy legislation allows a trustee in bankruptcy to review any transactions in which the corporation was involved with a non-arm's length party.

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(c) Personal Liability
Certain of the statutes under which directors of a corporation may incur liability for amounts which the corporation does not pay or remit are outlined in Part IV. The most significant sources of potential liability in a situation of insolvency relate to statutory obligations to pay employee wages, the withholding obligations for taxes and other source deductions associated with those wages and vacation pay. Under certain corporate statutes and employee protection legislation, directors may be liable to employees for up to 6 months' wages and 12 months' vacation pay if left unpaid by the corporation. This liability does not extend to termination payments in most provinces. Provincial legislation does make directors liable for these amounts in Manitoba and similar legislation was drafted, though not enacted, in Ontario. It is not inconceivable that other provinces may adopt the approach used in Manitoba of making directors liable, rather than leave employees without termination pay or have those amounts covered by provincial governments as the Ontario government is now doing. Liability for wages, vacation pay and source deductions may arise in situations where the directors thought adequate provision had been made. For example, cheques may have been issued to cover these amounts, but before the cheques clear the bank decides to take action against the corporation and, as a result, refuses to honour the cheques.
Directors are only liable for those amounts that accrued during the time that they were actually directors. As a result, when it becomes clear that the corporation will not be in a position to make those payments in the future, some directors have chosen to resign. While this may be the only prudent course of action in some circumstances, other steps may be taken to avoid the necessity of entire boards resigning. Directors may consider establishing a trust account so that money will be available for payments. This presupposes, of course, that the funds are available to be paid into that trust account. In some circumstances, an existing creditor may advance these funds rather than see the directors resign to ensure that the corporation has the benefit of experienced leadership during a period of restructuring. Other possibilities include arranging for letters of credit from a bank to fund such payments or to fund the payment of an indemnity by the corporation to the directors if they have personal liability for such payments. These arrangements and issues related to the validity are discussed in greater detail in Part V.
The Ontario Business Corporations Act has recently been amended to deal with the situation in which an entire board resigns. The Act now provides that any person who manages the corporation will be deemed to be a director and, thus, have all the directors' duties and responsibilities. Included in exception to this deeming provision is an officer who manages the corporation under the direction of a shareholder or other person and a lawyer, accountant or other professional who participates in the management solely to provide professional services.
Directors must be wary of relying on any directors' and officers' insurance to cover these payments. Before basing any decision on the existence of an insurance policy, the directors should ensure that the policy does cover the particular payments in question and that the policy is still in force. Most policies include a provision that the insurer may cancel a policy at any time so that it will have no liability for future claims.
7. Derivative Products
(a) Overview As noted, the board of directors must ensure that adequate management controls and procedures are in place to identify and address the risks to which the company is exposed. An observer of the financial scene through the first part of the 1990's could be excused for thinking that, for many companies, those risks primarily related to transactions in derivative products. While proper use of derivative products can be a desirable and appropriate strategy to enable a company to break apart those risks that are normally bound together in traditional financial instruments, it is possible, as the products become ever more complex, to end up with different and

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unforeseen risks. Such transactions have captured a significant degree of attention in the business press and have been blamed for some highly-publicized losses, with resulting litigation. Those lawsuits have focused, in large part, on whether dealers had properly advised the end users of the derivative products of the benefits and risks involved in the relevant transactions. This has led to debate, however, as to whether the senior management and the directors of those companies were sufficiently informed as to the relevant derivatives strategies and whether adequate internal reporting lines were in place.
As derivatives transactions move more into the mainstream of corporate finance, it is essential that directors and senior management assess the appropriateness of such transactions and then come to grips with appropriate risk-management techniques. This may represent an opportunity for a board of directors, or one of its committees, to examine and, if necessary, improve or adapt the company's existing risk management systems.
(b) What is a Derivative Product?
Derivatives are contracts which derive their value from underlying assets; for example, commodities, cash, shares and debt instruments. Derivatives have traditionally traded on exchanges in Canada. Parties to exchange-traded derivatives are allowed generally (in the case of options) or required (in the case of futures) to buy or sell assets in future at prices fixed at the time they entered into the contracts. Over-the-counter ("OTC") derivatives, on the other hand, are not traded on exchanges. They are direct contracts between counterparties. Unlike exchange-traded derivatives, counterparties of OTC derivatives do not buy or sell the underlying assets on which the value of derivatives is based. Instead, they deal only in the economic benefits of actual or notional assets. Interest rate or currency swap agreements are common forms of OTC derivatives.
The derivatives market can be defined both by product-type, such as exchange-traded or OTC derivatives, and also by participant-type. End users of derivative products are typically corporations, government entities, institutional investors and financial institutions that use derivative instruments to manage some risk related to their activities or who wish to take a position and, thus, enter into the transaction. Dealers are primarily banks and securities firms, and they typically enter into transactions with end users and manage the exposure related to the transactions on a portfolio basis.
(c) Issues for Corporate Directors
Derivative products are not a recent phenomenon; they are a standard way of managing the risks of fluctuating interest rates and currencies. Like any tool, however, they pose risks when wielded by people who do not know how to use them or when the potential financial implications begin to exceed what is prudent for a particular corporation. In addition, as with many products, they have evolved in sophistication and complexity giving rise to related financial implications that are much greater than they have been in the past. Initially, these products were considered somewhat obscure and properly the domain of specialists within the financial department without the need for broader input or systems of control. Part of the difficulty is that the increased use and complexity of these products requires companies to change their approach in dealing with them.
Companies can utilize derivative products as important risk-management tools by increasing or decreasing their exposure to particular risks. End users may find, however, that they have exposed themselves to new and unforeseen risks if they do not fully understand or properly manage a particular derivative product or strategy involving a series of such products.
Some end users of derivative products have reported major losses in the early 1990's. There have also been lawsuits between end users and dealers over derivative transactions that have soured. Such lawsuits may end up with companies exposing themselves as not sophisticated enough to have understood what they were getting

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into, which could well lead to counter-accusations by shareholders of a failure to execute fiduciary duty.
(d) What Should Corporate
Directors Do?
As part of its overall risk-management responsibilities, the board of directors should approve all significant policies related to risk-management and ensure that any risk management program includes a policy dealing with derivative products. Directors must be adequately informed of, and agree with, the nature and extent of the company's derivatives activities and associated risks in order to participate in creating and approving the implementation of such policies.
An initial step in developing this understanding is to read the recommendations found in recent reports on derivatives. In July 1993, the Global Derivative Study Group of the Group of Thirty ("G30"), a Washington-based organization of senior bankers and other market participants, issued its report on global derivatives transactions: "Derivatives: Practices and Principles". The G30 Report, one of the few reports prepared by market participants, is regarded as the seminal report and is intended for use by market participants. It proposed 20 recommendations for dealers and end users of derivative products and four recommendations for regulators.
Certain of the recommendations are particularly relevant to corporate directors, notably the recommendation that end users:

... should use derivatives in a manner consistent with the overall risk-management and capital policies approved by their boards of directors. These policies should be reviewed as business and market circumstances change. Policies governing derivatives use should be clearly defined, including the purposes for which these transactions are to be undertaken. Senior management should approve procedures and controls to implement these policies, and management at all levels should enforce them. (Recommendation 1)
The staff of the Ontario Securities Commission released a report, in draft form, in January 1994, in order to provide the Commission with a more informed view of the OTC derivatives market. The Report noted that a majority of the end users included in their survey had developed internal procedures to identify and keep track of the risks involved in derivative products activities. That report highlighted a number of key elements of adequate internal controls and reporting and approval procedures and should be specifically considered in this regard. In addition, it also identified as a risk the possibility that a key employee (or a select group of employees specializing in derivative products activities) might leave the company, which could result in the company not knowing, or not being able to track, the risks to which it was exposed as a result of open derivative products positions.
One of the essential components of any risk-management program is developing the ability to value derivative products. It is absolutely critical that the board of directors ensure that the company has the ability to calculate the value of every hedge position.

arts I and II of this guide have outlined general duties assigned to directors under the corporate law and certain of the additional requirements imposed on directors of public corporations by securities regulations and stock exchange rules. There is also a broad array of statutes which either charge corporate directors with additional responsibilities or make them directly liable for the actions or inactions of the corporation. This part outlines a sampling of these statutory responsibilities, the potential liabilities associated with them and the standard of conduct necessary for directors to discharge those responsibilities. In addition to the full range of statutory liabilities, it is possible for the directors to be held liable for certain common law breaches arising from the actions of the corporation. Directors may only be liable if they acted in such a deliberate and reckless way that they made the wrongful acts their own as distinct from the company's. For example, in the M & L Travel Ltd. case, the Supreme Court of Canada recently held the directors of a private corporation personally liable for a breach of trust by the corporation because they had full knowledge of the actions of the corporate trustee and, thus, knew of the breach of trust. They also participated and assisted in the breach. By contrast, in Peoples Jewellers, an Ontario court struck out a claim against the Peoples directors personally for negligent misrepresentation in connection with the issuance of debentures because the directors had always acted in their capacity as directors and never in their personal capacity. This decision is currently under appeal. Because directors are faced with these potential common law liabilities infrequently as compared to the other liabilities described in this guide, they have not been outlined here. Directors should at least note, however, that if their conduct as directors causes damage to a third party, that third party may, in some restricted circumstances, have a common law right of action against them.
>From a policy perspective, imposing personal liability on directors accomplishes two things. First, where a director has breached or has allowed the corporation to breach a statutory requirement, it provides a means for punishing the breach. More to the point, however, imposing personal liability on directors (and officers) creates an incentive for those individuals responsible for managing the corporation's business to ensure that the corporation fulfills its legal obligations. Liability is imposed on the directors in recognition of the fact that they have the ability to influence significantly the corporation's conduct. Liability is also imposed on the directors individually to encourage each individual director to play an active role in ensuring that the corporation complies with its obligations.
In broad terms, statutes impose liability on directors in one of three ways. For some offences, liability is imposed whether or not the director intended to commit the offence and indeed, whether or not the director even knew the offence was being committed. This is the least common type of directors' liability and is often referred to as "absolute liability", meaning that a director may be liable under a statutory

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provision simply because the offence in question occurred. The fact that a director was not aware that the offence was being committed or even that the director had taken all available action to prevent the offence from being committed may not be a defence. Liability for employee wages and vacation pay under certain provincial employment standards legislation is one example of this type of liability.
The second type of offence imposes liability on directors unless they were diligent. This type of liability is typically imposed for regulatory or public welfare offences. The "due diligence defence" allows directors to avoid liability if they have followed appropriate steps or adopted adequate procedures, such as making the appropriate inquiries, reviewing the documentation provided to them, ensuring appropriate controls or procedures are in place, consulting experts where necessary and giving thoughtful consideration to the issue. The due diligence defence is available for a broad range of offences, including prospectus liability under provincial securities laws and certain environmental offences.
The third type of offence imposes liability on directors who "authorized, permitted or acquiesced" in the commission of an offence by the corporation. This wording implies knowledge that the action constituting the offence was being committed and appears in many statutes. These offences are quite similar in their operation to the offences which specifically provide a due diligence defence. A defence is available to directors who can prove that they took all reasonable care to comply with their obligations and that they had an honest and reasonable belief that they had done so, even if this belief was mistaken.
Certain of the statutes under which directors are most commonly exposed to liability are discussed below. Directors should look to their legal advisors to outline their particular exposure to liability under these and other statutes in the context of the corporation's business and the business of its subsidiaries. Directors should also ensure appropriate procedures are put in place to promote compliance with statutory requirements and that these procedures are periodically reviewed to confirm compliance.
The TSE Committee's Final Report contained recommendations for legislative reform which included the suggestion that all corporate laws in each of the federal and provincial jurisdictions be reviewed and modified to ensure that directors are provided with an effective due diligence defence for liabilities imposed as a result of their actions as members of the board. The TSE Committee also recommended that legislation imposing personal liability upon directors which no longer serves the purpose for which it was enacted be repealed or modified for the appropriate level of liability. In this way, the TSE Committee hopes to alleviate one of the difficulties experienced in recruiting effective directors and to avoid excessive conservatism in corporate decision-making as a result of concerns about liability.
1. Impairment of Capital and Corporate Solvency Tests
(a) Types of Payment
The corporate statutes seek to maintain the financial stability of the corporation by prohibiting certain actions by the corporation if it does not meet the solvency tests set out in the statute. These solvency tests are described below. Directors who vote for or consent to a transaction when the corporation does not meet the solvency tests may be liable for amounts paid out by the corporation which it does not otherwise recover. In other words, the directors who cause or allow the corporation to take certain action which leads to its insolvency are required to restore to the corporation the funds which the corporation expended in the course of this action. The list of transactions for which directors could incur this type of liability includes:
€ issuing shares for property or past services which have a fair market value less than the money the corporation would have received if it had issued the shares for money (unless the director did not

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and could not reasonably have known that the corporation would have received more if the shares had been issued for money);
€ any of the following actions in contravention of the statutory solvency tests, which are described in greater detail below:
€ purchase, redemption, retraction or other acquisition of shares of the corporation;
€ payment of a dividend;
€ provision of loans, guarantees or other financial assistance to certain related parties;
€ payment of an amount to a shareholder who has exercised statutory dissent rights;
€ payment to an officer or director of an indemnity prohibited by the corporate statute; and
€ paying an unreasonable commission to any person purchasing shares of the corporation.
Since directors only incur liability for these transactions if they vote for or consent to the resolution authorizing the transaction, they should bear in mind that they will be deemed to have consented to a resolution unless their dissent is registered in the manner and within the time prescribed by statute. The procedure for registering a dissent is described in Part II.
An action against a director for authorizing the types of transactions listed above must be commenced within 2 years of the date of the resolution authorizing the unlawful act.
(b) Corporate Solvency Tests
The corporate statutes prohibit a corporation from taking certain action if the corporation would fail to meet two tests after taking that action. These tests are commonly referred to as solvency tests, although one deals with solvency and the other deals with impairment of capital. The two tests are discussed here in the context of the declaration of dividends, but a version of these solvency tests also applies to the redemption or retraction of shares, financial assistance and the other types of transactions listed above. In the case of dividends, the solvency tests are intended to prevent directors from declaring dividends out of the corporation's capital or otherwise distributing to shareholders, assets of the corporation which should remain in the corporation for the protection of creditors. While lenders do not usually rely exclusively on these statutory provisions to protect them from corporate actions which might jeopardize the corporation's ability to pay the creditors and may well require covenants which impose other or more stringent tests, the solvency tests are intended to provide a measure of protection against the corporate assets being stripped away.
The solvency test prohibits a corporation from declaring or paying a dividend if there are reasonable grounds for believing that the corporation is unable to pay its liabilities as they become due or would be unable to do so after paying the dividend. The inability to pay liabilities as they become due will have different meanings in different circumstances. Generally however, if a corporation could only satisfy its ongoing liabilities by liquidating assets fundamental to running its business, the directors could likely not conclude that the test had been met. If, on the other hand, the directors determine that the corporation would need to sell one significant asset in order to meet a large and unusual liability, they might still conclude in good faith that this did not result in the corporation being unable to meet its liabilities as they became due.
The impairment of capital test prohibits the corporation from declaring or paying a dividend where there are reasonable grounds for believing that the "realizable value" of the corporation's assets would, as a result of the dividend, be less than the aggregate of its liabilities and the stated capital of all classes of shares. The manner in which assets are valued will depend on the corporation and its circumstances. It is generally

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reasonable to value the assets on a going concern basis, unless there is some reason to believe that the corporation will be wound up or put into some form of solvency-related proceeding in the near future or that an urgent and significant disposition of its assets is planned. Because the test refers to the "realizable value" of the corporation's assets, as measured against its liabilities and stated capital, the value of the assets must be established on the basis of some sort of notional sale. While valuation should take into account taxes payable arising from the sale as well as legal and other costs associated with a disposition of assets, the directors are also entitled to assume that the sale will be implemented on a tax efficient basis, so long as that assumption is a reasonable one. Moreover, discounting such costs may be justified if disposition is not imminent.
Under some corporate statutes, the test is less stringent for corporations with wasting assets. These are assets which are necessarily consumed in the operation of the corporation's business. These provisions apply to corporations which have as their principal operations a producing mining or oil and gas property, or which have 75% of their assets of a wasting character. They also apply to corporations incorporated to acquire assets, liquidate them and distribute cash to shareholders. Such corporations are not required to meet the solvency tests imposed on other corporations. Rather, they are entitled to pay dividends out of funds derived from their operations even if the payment reduces the value of their assets to less than their stated capital, so long as they can still meet their liabilities.
The tests are prospective, requiring directors to determine whether the corporation would be able to meet its obligations as they become due. No time frame is given and no guidance is provided for the definition of the term "liabilities". The corporate statutes do not indicate, for example, whether contingent liabilities such as guarantees should be included. The tests are also based on values which cannot be determined with certainty at the time the directors must decide whether to declare a dividend. The directors cannot (and are not expected to) determine with certainty the realizable value of the corporation's assets, because this value can only be known when the assets are sold. Nor are they expected to predict future events. For example, after a corporation has paid a dividend, a significant depreciation in the value of a corporation's inventory � as has happened to corporations holding real estate � may call into question the ability of the corporation to satisfy its liabilities and may with hindsight make the payment of the dividend seem imprudent. The directors only need to be satisfied, at the time the resolution is passed to declare and authorize the payment of the dividend, that there are no reasonable grounds for believing that the tests would not be met. If the directors determine in good faith that the corporation meets the tests, based on an estimate of the value of assets which they reasonably believe, in good faith, to be true at the time the dividend is declared and payment is authorized, the courts have indicated that the directors will not be liable if the value of those assets is subsequently lost.
(c) Defence and Penalty
Whether the corporation meets the solvency tests is a question which in most cases must be determined by the board. However, under the corporate statutes, the directors are entitled to rely on the corporation's financial statements, which an officer of the corporation or a written report of the auditor represents to fairly reflect the financial condition of the corporation. In appropriate cases, directors may also rely on outside advisors. As discussed in Part I, such reliance must be in good faith and reasonable.
Directors will not be able to look to the corporation's auditors for opinions on whether the corporation meets the solvency tests. Chartered accountants in Canada were advised in an October 1988 release by the Canadian Institute of Chartered Accountants not to provide opinions (that is, positive or negative assurances) on matters relating to solvency. The rationale for this position is that solvency is a state of affairs which must be determined, at least in part, prospectively under the

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prescribed test and, therefore, is not a matter on which accountants are prepared to opine. This position illustrates the challenge faced by directors in seeking to determine whether the tests have been met, particularly in circumstances where the corporation could be said to be near the margins of the test.
Directors who consent to any of the transactions described above when the corporation does not satisfy the solvency tests may be jointly and severally liable to repay to the corporation any amounts distributed or paid by the corporation as a result of that transaction. Any potential for liability ceases 2 years after the date of the resolution approving the transaction. Directors who are found liable are entitled to look to any other directors who also consented to the resolution for their share of the amount in question. Such directors may also apply to a court for an order requiring the person who received the money to repay that amount to the corporation.
2. Insider Trading
As noted in Part III, regulation of insider trading is intended to promote fairness in the capital markets. Persons who have information about a corporation by virtue of their relationship with that corporation should not be in a position to use that information to trade in securities of the corporation or to assist others to trade in securities of the corporation before that information is publicly disseminated.
(a) Directors as Insiders
Directors are insiders of the corporation on whose board they serve, but they are also deemed to be insiders of any other corporation in which their corporation owns or controls more than 10% of the voting securities.
The insider rules have two aspects. First, as insiders, directors must report to the securities authorities any trade they make in securities of the corporation in which they are insiders. This is discussed in greater detail below under "Insider Trading Reports". In addition, because they are in a "special relationship" for securities law purposes to any corporation in which they are insiders, they may be liable if they trade in securities of that corporation with knowledge of a material fact or material change that has not been generally disclosed. In addition, directors may incur liability if they pass that information to someone else who trades with knowledge of the information (commonly referred to as a "tipee"). This is discussed in greater detail below under "Use of Inside Information".
(b) Insider Trading Reports
Persons who hold securities in the corporation are required to file an insider report when they become insiders. When a person who holds securities of a corporation is appointed to the board of that corporation, for example, or when an existing director acquires securities of the corporation for the first time, that person must file an initial report. The report must be filed within 10 days of the date on which the person became an insider or within 10 days of the end of the month in which the person became an insider, depending on the jurisdiction. When directors trade in securities of entities in which they are insiders, they must file a report of that trade within 10 days of the trade or within 10 days of the end of the month in which they make the trade, again depending on the jurisdiction.
The extent of the reporting requirement may also vary from jurisdiction to jurisdiction. In addition, there are various definitions which broaden the term "insider" so that it covers other entities within a corporate group. Given the potential degree of complexity and detail, it is standard practice for most public corporations to have a memorandum prepared for their directors and senior officers to assist them in complying with these requirements. The regulators consider timely and accurate reporting a priority and it is, therefore, very important for directors to meet these requirements within the time periods prescribed.

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Insider reports are filed with the appropriate securities commissions as well as with the federal government if the corporation is federally incorporated. Insider reports are public information and are often tracked and reported by the financial press. As an internal administrative matter, the corporation's legal or administration department is frequently responsible for filing the insider trading reports for the corporation's directors, but directors should bear in mind that they, and not the corporation, will bear the liability for failing to file their insider trading reports as required. In Ontario, failure to file may result in a fine of up to $1,000,000 or 2 years in prison, or both.
(c) Use of Inside Information
Under both the corporate and securities statutes, directors are liable for using confidential or "inside" information about the corporation to trade in securities of the corporation or for passing such information on to someone else. The provisions and language used to describe these liabilities vary depending on the statute, but include "material fact", "material change", "material information" and "confidential information". Many, though not all, of these concepts may apply to directors who are insiders of private corporations as well as those who are insiders of public corporations.
A director who trades with knowledge of such information or who provides that information to someone else may encounter liability on three levels. First, the director may be subject to a fine of not less than the profit made, but not more than triple the profit, up to a maximum of $1,000,000. and up to 2 years in prison. If a corporation is convicted of insider trading, every director who authorized or acquiesced in the offence is also guilty and is liable for damages resulting from the trade and for a fine of not more than $1,000,000 and 2 years in prison. The director may also be liable to the person who traded with the director or with the person the director advised of an undisclosed material change or material fact. Damages may be up to the amount by which the transaction price was affected by the confidential information available to one, but not the other party. Finally, the director will be liable to the corporation for any gain realized by insider trading or tipping.
(d) Defences
There are a number of defences available to a director who has been charged with insider trading. Proof that a director reasonably believed that the information had been generally disclosed may be a defence. Similarly, if the other party to the transaction knew about the undisclosed information or ought reasonably to have known, the director may not be liable. If the trading took place in "innocent" circumstances such as the purchase of shares by a director in an automatic plan such as a dividend reinvestment plan or share purchase plan which was in place before the director became aware of the confidential information, or where it was made to fulfill a legally binding obligation entered into prior to the acquisition of the undisclosed information, the director may not be liable. Chinese wall defences may also relieve directors of liability in situations where a corporation made an investment which constituted insider trading, but can show that no director, officer, partner, employee or agent of the firm who was involved in the investment decision had actual knowledge of the confidential information.
Similarly, a number of defences are available to a charge of tipping. For example, if a director informs a third party of an undisclosed material fact or a material change in the necessary course of business, that action does not constitute tipping. However, if a director informs a third party of an undisclosed material fact or material change other than in the necessary course of business, the director will have a defence if the person who bought or sold shares of the corporation knew or ought reasonably have known about the information.
While certain defences to insider trading and tipping may be available, there are only limited situations in which they will be applicable. The potential fines on the other hand are very significant and can be up to triple the profit made or $1,000,000.

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(e) When is Information Disclosed
The securities rules permit trading to commence when information has been "generally disclosed". It is important for directors to note that this is a term that has specific meaning. The issuance of a press release alone is not sufficient; there must be an opportunity for the information to be disseminated and absorbed by the marketplace. As a general rule, insiders should not trade for at least 24 hours after the press release has been issued. This period may be longer, up to a week, if the information is not picked up and disseminated to the public through the news media.
3. Disclosure Documents
Liability for disclosure documents arises in two ways: quasi-criminal liability for failing to comply with requirements such as the requirements to file financial statements in accordance with prescribed rules and civil liability for misrepresentations in certain documents such as prospectuses.
(a) Ongoing Disclosure Documents
Public companies are required to file various ongoing or continuous disclosure documents. Any director of a corporation who "authorized, permitted or acquiesced" in the filing of documents that are not in compliance with those requirements commits an offence. Such liability could occur, for example, as a result of disclosure or lack of disclosure in:
€ annual and interim financial statements;
€ information or management proxy circulars; or
€ material change reports.
On conviction, directors may be subject to a fine of up to $1,000,000, 2 years in prison, or both.

(b) Prospectuses
Certain documents are so fundamental to the public disclosure system and the functioning of the capital markets that they also have the potential for exposing directors to personal civil liability. The most commonly used of these documents is the prospectus. A number of persons and entities, including directors, are involved in the creation of a prospectus and liability is imposed on many of them for any "misrepresentation".
The issuer of the securities or a selling shareholder on whose behalf the distribution is being made, is liable and has no defence where a misrepresentation appears in the prospectus. The underwriters of the offering and any other person who signs the prospectus, such as a promoter, are also liable, but may have a due diligence defence. If reference is made in the prospectus to any report, opinion or statement of an expert, that expert will be liable with respect to those references, but is also provided with a due diligence defence. Similar liability applies to misrepresentations contained in take-over bid circulars.
A director will not be liable to a purchaser who purchased securities offered by prospectus containing a misrepresentation for an amount in excess of the price stated in the prospectus at which the securities were offered to the public or for any damage which the director proves does not represent the depreciation in value of the security as a result of the misrepresentation. A purchaser must bring an action with respect to a misrepresentation in a prospectus within 180 days of becoming aware of the misrepresentation, but, in any event, before the end of 3 years from the date on which the securities were purchased.
The main defence available to directors to a claim by a purchaser that a prospectus contains a misrepresentation is the due diligence defence. In other words, directors will be liable if they failed to conduct a reasonable investigation. The steps which directors should take in order to show that they conducted an adequate investigation are discussed in greater detail in Part III.

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Directors have a number of other defences to a claim by a purchaser that a prospectus contained a misrepresentation:
€ the purchaser was aware of the misrepresentation at the time of purchase;
€ the prospectus was filed without the director's consent and the director gave reasonable general notice of this fact or the director withdrew consent and gave reasonable general notice of this fact and of the reasons for withdrawing consent; or
€ the misrepresentation appeared in an expert's portion (that is, a reference to a report or opinion of an expert) or it was made by an official person or contained in an official statement and the director had reasonable grounds to believe that there was no misrepresentation.
4. Liability for Offences Under the Corporate Statutes
The corporate statutes impose a number of obligations on the corporation. To ensure compliance by the corporation, the corporate statutes also impose personal liability on a director who knowingly authorizes, permits or acquiesces in the corporation failing to comply with certain provisions. The offences for which a director may incur such liability under the Canada Business Corporations Act include the following:
€ failure of the corporation to send a proxy to shareholders at the same time as they are given notice of a shareholders' meeting as required by the CBCA;
€ failure by the corporation to send a management proxy circular to shareholders and to the Director under the CBCA before soliciting proxies;
€ failure by the corporation to comply with take-over bid requirements under the CBCA;

€ failure by the corporation to comply with requests for information under the CBCA with respect to insider trading, proxies or take-over bids; and
€ the inclusion by the corporation of an untrue statement of a material fact in any document required under the CBCA or the omission by the corporation of a material fact in such a document.
Directors may be liable for fines of up to $5,000 or prison terms of up to 6 months, or both, whether or not the corporation itself has been prosecuted or convicted for the offences described above. The defences available to directors will vary with the particular offence and the circumstances, but, in most cases, directors must have knowingly authorized, permitted or acquiesced in the commission of the offence before they will incur liability.
5. Environmental Legislation
Liability for environmental offences vies with liability for employee wages as the highest profile liability facing directors. Anyone may incur liability under any one of a number of statutes for causing or permitting damage to the environment and directors may be subject to this liability if they themselves cause or permit damage. In addition, however, many of the environmental statutes in Canada make directors liable for the environmental offences committed by the corporations they serve. This is the liability which is of particular concern to directors who may have no particular knowledge of or control over corporate activities which may cause environmental problems.
In the last few years there has been a significant increase in the number and severity of Canadian environmental laws. Much of this legislation has developed in a piecemeal fashion in response to particular concerns. As a result, environmental legislation, regulation, policy and guidelines are neither comprehensive nor coherent. In addition to the general environmental protection statutes such as the Canadian Environmental Protection Act and Ontario's Environmental Protection Act, there are a host of statutes

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dealing with water, air, pesticides, mining, oil and gas and waste management which impose specific environmental protection requirements. These requirements include among their sanctions, the imposition of liability on the directors of a corporate offender. Keeping abreast of legal developments, let alone complying with them, is difficult.
(a) Offences
The Canadian Environmental Protection Act ("CEPA") is typical of most environmental legislation across Canada. Under CEPA, a director may incur liability for offences of the corporation if that director "directed, authorized, assented to, acquiesced in or participated in the commission of the offence". The effect of this wording is that, for the purposes of CEPA and most other most environmental legislation in Canada, directors will be subject to liability as directors only if they had knowledge of the actions which constituted the offence.
Ontario's Environmental Protection Act and certain other environmental statutes go beyond the type of provision found in CEPA. They require directors to take "all reasonable care" to prevent the corporation from unlawfully discharging a contaminant into the environment. Under these statutes, directors have an obligation to act proactively to ensure that the corporation is in compliance.
(b) Due Diligence Defence
The criminal liability of directors for the environmental actions of the corporation is not an absolute liability. Directors may avoid liability if they are able to show that they exercised appropriate diligence to ensure that the corporation complied with environmental legislation. The onus may be on the directors to establish that such diligence was exercised.
The ability to successfully raise a due diligence defence will depend on the steps taken by directors prior to the commission of the offence. A director's diligence is founded on an understanding of the issues, formulation of appropriate corporate policies, delegation to qualified personnel of the responsibility for implementing the policies and ensuring compliance by establishing a monitoring system which enables the director to confirm that the policies established are being followed and employee concerns addressed. This action should be appropriately documented in board minutes as well as reports from experts and from management. A discussion of the procedures which a board should consider implementing to ensure that it has met the requisite standard of care is set out in Part III.
(c) Penalties
There are several types of liability which a director may face in connection with environmental legislation. Directors may be subject to substantial fines or imprisonment or may be named in orders to implement and pay the costs under preventative, clean-up and remedial orders.
Fines or imprisonment, or both, may be imposed where a court determines that punitive action against a director is appropriate. Fines may range from $10,000 to $100,000 per day for directors ($50,000 to $2,000,000 per day for the corporation). Under CEPA, the individual is subject to the punishment that is provided for the particular offence committed by the corporation. In addition to daily fines, the potential penalties under that statute range up to a fine of $200,000 plus 5 years' imprisonment for more serious offences. For certain offences, such as intentional or reckless disregard for an environmental disaster, or for the lives and safety of others, there is no maximum limit to the fine, and there may even be the potential for prosecution under the Criminal Code with a maximum penalty of life imprisonment.
There has been a steady increase in charges relating to environmental offences laid both against individuals and corporations in Canada over the last several years. For example, from 1985 to 1993, the number of charges in Ontario increased from 150 to 1,600. Penalties have also increased. Total fines imposed in Ontario for environmental offences

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in 1993 were $2,500,000, and in an Ontario decision, an executive of a hazardous waste disposal company was sentenced to 8 months in prison. The factors which a court will take into account when imposing a sentence include the nature of the offence, the deliberateness of the action, the extent of cooperation with officials, whether commitments have been made to achieve compliance and the speed and efficiency of rectification.
Directors may be named in remedial orders to implement and pay the costs of a clean-up, usually where they can be shown to have been directly responsible for the pollution. Orders of this nature are not intended to be punitive and, if the corporation is financially capable of complying with the orders, it is unlikely that such orders will be issued against the directors.
Statutory civil liability for losses or damages resulting from actions commencedunder environmental statutes may arise in the case of a spill of a toxic substance. A director could be liable to a third party if the director had ownership, charge, management or control of a pollutant immediately before it was spilled. To date, there have been no decided cases in which a director's statutory civil liability was considered. Even where a statute does not impose civil liability on a director, liability could arise under the common law.
6. Pension Matters
Under pension benefits legislation, the corporation is frequently the "administrator" of the employee pension plan. In such cases, the task of fulfilling the obligations associated with the administration of the plan and the administration and investment of the pension fund falls to the board of directors. In most cases, the board delegates all or a portion of that authority to a committee of the board or to a committee which may be composed of board members, employees of the corporation and outside advisors, or to individuals employed in the company's finance or human resources departments.
While the board is justified in delegating to others, board members continue to have responsibilities. In addition to their duty as fiduciaries of the corporation, the directors must ensure that the corporation fulfills its obligation with respect to the pension fund to "exercise the care, diligence and skill that a person of ordinary prudence would exercise in dealing with the property of another person". If directors act as administrators of a plan in some jurisdictions such as Ontario, they must use, in the administration of the plan, and in the administration and investment of a pension fund, all relevant knowledge and skill that they possess or, by reason of their profession, business or calling, ought to possess.
The board must determine the degree of delegation of responsibility for the pension plan which is appropriate. The board should ensure that individuals with appropriate skill and experience are designated to deal with pension matters and that there is in place a systematic set of procedures and evaluation measures to supervise and track the performance of those responsible for the plan. In Ontario, the board of directors or its delegate must develop a set of investment guidelines and review, confirm or revise those guidelines annually. It is prudent for the board to require periodic reports on the performance of the plan.
Under Ontario regulated plans, where a corporation is convicted of an offence under the pension benefits legislation, any director who participated in the offence is also liable and is subject to a fine. In addition, where a corporation is convicted of an offence for failing to submit payment to a pension fund or insurance company, any director who participated in that offence may be required to pay the outstanding amount in addition to any fine.
7. Employee-Related Matters
Liability for amounts not paid to or on behalf of the corporation's employees is among the most significant liabilities that a director may incur. Without a systematic and reliable audit

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and reporting system, it is also among the most difficult liabilities to avoid if the corporation becomes financially unstable. Because individual directors are only liable for payments which should have been made while they were directors, the prospect of this liability has prompted directors to resign when they recognize the corporation might not be able to make these payments in the future. The nature of directors' liability for employee wages, vacation pay and termination pay, as well as liability for various source deductions, is set out below. Liability for the corporation's obligation to deduct and remit income taxes on behalf of its employees is discussed in section "Tax Liabilities" in this part.
(a) Wages, Vacation Pay and
Termination Pay
Many of the corporate statutes and provincial employment legislation impose liability for employee wages and vacation pay on directors. Under the Canada Business Corporations Act, for example, directors may be liable for, all debts up to a maximum of 6 months' wages payable to each employee for services performed while they were directors. The Supreme Court of Canada concluded in Crabtree Estate that directors are not liable for termination pay (pay in lieu of notice) under the CBCA. Very few provinces impose liability on directors for termination pay.
In Canada, the activities of a corporation (and the corporation's relationship with its employees) are subject either to provincial or federal legislation. For example, broadcasting and some financial institutions are under federal jurisdiction, while manufacturing would generally be subject to provincial jurisdiction. In industries under provincial jurisdiction, directors may be liable for employee wages under provincial employment standards legislation as well as under the corporation's governing corporate statute. In those industries, employees may proceed in one of two ways if they are not paid for wages or vacation pay. If they proceed under the provincial employment standards legislation, they may present their claim to the provincial employment standards branch. If that branch believes the claim is valid, it will pursue the matter with the corporation and the directors on behalf of the employees. If the provincial authorities do not support the claim or if the employees do not enlist their help, the employees themselves may institute an action against the corporation or the directors under the relevant corporate statute.
If the business of the corporation is under federal jurisdiction, employee relations are governed by the Canada Labour Code which now imposes liability on directors for wages and other amounts (including vacation and termination pay) up to a maximum amount of 6 months' wages. The entity's governing statute may also impose liability for wages and vacation pay (as do the federal corporate statute and the Bank Act).
The corporate statutes which impose liability for employee wages on directors also impose certain procedural requirements if an employee wishes to sue the directors. Under the CBCA, for example, directors will not be liable for amounts owing to employees unless they are sued while they are still directors or within 2 years of the date on which they ceased to be directors. In addition, directors may not be sued for these amounts unless:
€ the corporation has been sued successfully within 6 months of the date when the wages were due and the corporation did not satisfy the judgment in full;
€ a claim for the wages was proved within 6 months of the date on which the corporation was dissolved or on which it commenced liquidation and dissolution proceedings (whichever is earlier); or
€ a claim for the wages has been proved within 6 months of the date on which the corporation made an assignment, or a receiving order was made against it, under the Bankruptcy and Insolvency Act.

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Directors are jointly and severally liable with all of the other directors for these amounts, meaning liability for the entire amount may be imposed on a single director, on several of the directors, or on all of them. Any director who has paid an employee claim under these provisions is entitled to look to the other directors to contribute their share of the amount paid.
(b) Source Deductions
A corporation is required to deduct certain amounts from its employees' wages or salaries and to remit those amounts to various levels of government. These are payments which the corporation makes on behalf of the employees, and failure to make such payments is treated in much the same way as failure to make payments on account of wages and salaries. Typical source deductions include income taxes and employees' premiums for unemployment insurance and contributions to the Canada Pension Plan. If the corporation fails to deduct and remit these amounts, those individuals who were directors at the time the amount should have been remitted may be jointly and severally liable for that amount as well as for interest and pen alties on these amounts.
A due diligence defence may be available to directors who have taken the steps necessary to ensure that source deductions are being made and remitted. Some corporations have adopted a procedure requiring senior management, such as the chief financial officer, to certify to the board on a regular basis that all source deductions have been remitted and paid by the corporation to the appropriate authority. When a company is experiencing no financial difficulty, it may be sufficient to do this on an annual basis, perhaps coincident with the approval of the annual financial statements. When signs of financial instability appear, this certificate or other confirmation should be obtained more frequently. Advice should also be obtained about whether other steps should be taken to establish a due diligence defence, such as those described in the next section on tax liabilities.
(c) Occupational Health and Safety Legislation
Provincial occupational health and safety legislation is designed to ensure that employees work in an environment that is safe and free of hazards and liability for a corporation's failure to comply with health and safety legislation in most provinces may extend to the directors of the corporation. In Ontario, for example, directors must take "all reasonable care to ensure that the corporation complies" with the provincial requirements. While provisions of this nature impose an obligation on directors to take active steps to ensure compliance, they also allow a defence of diligence for any director charged with an offence under the legislation. The test of due diligence is a factual one and the meaning of "reasonable care" may depend on the industry in which the corporation operates. In most cases, the care taken by directors should include ensuring that management has identified areas of operation in which precautions should be taken to protect workers from human error and from other sources of possible harm. Training employees and supervisors will also be critical to the discharge of this responsibility. It is generally accepted that a director will not be held personally liable if employees and supervisors who have received the appropriate training and education and who have been properly instructed and supervised are derelict in their own duties.
If there is a standard practice of care that is recognized for a particular operation or industry, directors should ensure that the corporation at a minimum adheres to that standard. However, this standard of care may not be sufficient if the circumstances warrant increased care. In assessing the level of care that is reasonable, the factors that should be considered include:
€ the gravity and the likelihood of the harm that could result; and
€ the alternatives available to a corporation to minimize both the possibility of a contravention occurring and the potential harm which could result.

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Penalties will vary from province to province. In Ontario, directors who fail to comply with their obligations under the Occupational Health and Safety Act may be subject to fines of up to $25,000 and prison terms of up to 1 year.
8. Tax Liabilities
(a) Source Deductions and Other Remittances
Under the Income Tax Act, individual directors of a corporation can be held personally liable where the corporation fails to deduct or remit to Revenue Canada the prescribed amounts for certain payments by the corporation including:
€ salaries, wages, pension benefits, retiring allowances and certain other amounts paid to employees or former employees; and
€ amounts paid or credited to non-residents of Canada that are subject to Canadian withholding tax.
Actions against a director must be commenced within 2 years after the date on which a person ceased to be a director of the corporation which failed to make the payment and can only be commenced if Revenue Canada has first taken certain specified steps to attempt to collect the liability from the corporation. Furthermore, the courts have generally only imposed liability when the corporation's failure to withhold and remit occurred before the individual ceased to be a director.
Individual directors are not liable for the corporation's failure to withhold and remit the required amounts from employee wages and payments to non-residents if they are able to demonstrate that they exercised the degree of care, diligence and skill to prevent the failure to withhold or remit that reasonably prudent persons would have exercised in comparable circumstances. Revenue Canada has taken the position that this due diligence defence requires directors to take positive steps to ensure that the corporation makes the required remittances. Positive steps may include establishing controls for proper withholding and requiring reports from the chief financial officer on the implementation of those controls, as well as confirming that remittances have been made during all relevant periods. Where the corporation is in financial difficulty, Revenue Canada is of the view that directors should obtain, from the financial institution extending funds for the payment of salaries and wages, an enforceable undertaking to pay all related source deductions when due or, if this is not possible, establish a separate payroll trust account for the deposit of the gross payroll. Payments would be made to both the employees and to Revenue Canada from this account.
There has been considerable litigation surrounding the standard of care required to establish the due diligence defence. Consistent with Revenue Canada's published position, directors have generally been held to a high standard of care by the courts. Therefore, directors must take a "hands-on" approach to seeing that source deductions are made, since a failure on the part of a director to take positive steps will likely make the director liable. Directors who have not played an active role in the affairs of a corporation are generally as much at risk as those who have. Moreover, the responsibility to ensure that source deductions are remitted cannot be delegated to other directors or officers of the corporation.
The courts have stated that while other statutes may permit directors to undertake risks in running a business, the Income Tax Act does not allow for any risk taking in respect of source deduction obligations.
(b) Offences of the Corporation
In addition to the other liabilities discussed in this section, the Income Tax Act imposes liability on a director for any offence committed by the corporation under the Income Tax Act if that director "directed, authorized, assented to, acquiesced in or participated in" the commission of the offence, whether or not the corporation has been prosecuted or convicted.

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(c) Clearance Certificates
The Income Tax Act generally requires certain persons, including an assignee, liquidator, administrator or other "like person", to obtain a clearance certificate from Revenue Canada before distributing any property of the corporation under that person's control. Failure to obtain a clearance may result in that person being liable for the unpaid taxes, interest and penalties of the corporation. Whether a director of a corporation is a "like person" will depend on the circumstances of each case and, in particular, upon whether the director, in approving the distribution, is in fact acting in a capacity similar to the specified positions. Accordingly, where the director may be acting in such a capacity, advice should generally be obtained about whether the corporation should apply for a clearance certificate before the directors approve any significant distribution of property.

(d) GST
A director may also be held liable for any net goods and services tax ("GST") payable by the corporation under the Excise Tax Act. This liability is based on similar provisions to those contained in the Income Tax Act. Liability is imposed only on payment obligations which arose during an individual's tenure as a director, and a director may avoid liability by establishing a "duediligence defence". The Excise Tax Act also contains offence provisions which are similar to those in the Income Tax Act outlined above.
(e) Other Tax Statutes
A director may be subject to liability under a number of other federal and provincial tax statutes, depending on the nature of the corporation's business. For example, under Ontario's Retail Sales Tax Act, a director's potential liability is similar to that imposed in the income tax and GST contexts.

In agreeing to act as directors of corporations, individuals accept significant responsibilities and with those responsibilities the risk of being exposed to a host of potentially significant liabilities. Many of these liabilities have been canvassed in this guide. Individuals will likely continue to accept the responsibility of acting as corporate directors if they are able to minimize the degree of risk to which they are personally exposed. In most cases, this can be accomplished through an appropriate risk-management strategy which is consistently implemented.
A risk-management strategy for directors should be designed to meet two broad objectives. First, it should limit the potential liability to which the directors are exposed. Both the common law and the statutes offer a number of opportunities for directors to limit this liability based principally on the directors' diligence. This and certain other methods of limiting liability are discussed in Section 1 below. Second, the risk-management strategy should seek to shift as much of the remaining risk as possible away from the directors. In this regard, indemnities or insurance policies are discussed in Sections 2 and 3 below.
While the law subjects corporate directors to a number of potentially onerous liabilities, it also seeks to protect directors who have acted in a manner consistent with their fiduciary duties. The fact that diligence protects a director in many circumstances from liability and the fact that the corporate statutes permit a corporation to protect its directors from personal liability through indemnities and insurance indicate that it is not the intention of the legislators, the regulators or the courts to penalize directors if they exercise their business judgment diligently, honestly, in good faith and with a view to the best interests of the corporation.
1. Limiting the Risk
The most effective way for directors to limit their liability is to perform their duties diligently, both individually and collectively as a board. In addition, certain other actions may protect directors in circumstances where diligence is not enough. For example, the implementation of a unanimous shareholder agreement where appropriate will limit certain liabilities. The segregation of funds into trust accounts to cover directors' liabilities may ensure that the necessary funds are available to protect the directors from personal exposure. In certain extreme cases, only the resignation of directors from the board may prevent the directors from being liable for an event which has not yet occurred, but is expected to take place. Each of these methods of limiting liability is discussed in this section.

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(a) Discharge of Responsibilities
The risk of liability is minimized if directors ensure that all duties are discharged fully and all statutory requirements imposing specific liability on directors have been met. As a general matter, directors should commit themselves to attending all meetings of the board. If absence from a meeting is unavoidable, they should inform themselves fully about what was done and form a view about whether they approve or disapprove of the actions taken. If they disapprove, they should ensure their dissent is recorded since liability under the corporate statutes for certain actions is imposed only on directors who voted for or consented to the action. In certain potentially contentious situations, directors should consider protecting themselves by obtaining professional advice on their duties and responsibilities and acting in relianceon such advice. Directors should insist that management inform them on a timely basis of all significant or exceptional circumstances that may expose them to liability. A more extensive list of suggestions to help directors discharge their responsibilities is set out at the end of this guide. A director's focus should be on careful attention to the business and affairs of the corporation and on the establishment and operation of early warning reporting systems to identify potential problems for senior management and, where necessary, for the board before they become real problems.
Whatever the conduct of an individual director, there are many situations in which the conduct of the board as a whole will be under scrutiny. Although duties are imposed on directors individually, directors act collectively as a board, making decisions for the corporation which no individual director would have the authority to make. In 1986, the Honourable Willard Estey commented on this aspect of directors' liability in the report of the Royal Commission on the failure of the Canadian Commercial Bank and Northland Bank:

It is each director, not the Board, who is under certain duties, and the conduct of directors can only be assessed individually. Thus it is most unfair to lump all directors together in any assessment of Board action. Some longtime members of the CCB Board swam against the management current through many years. Some recent additions to the Board recognized many of the problems of the past. Others seemed to make little contribution. The Board here, of necessity and for the purposes of the Commission's mandate, must be assessed and adjudged as a unit over the life of the bank. Individual members may well suffer from a description that does not fit their individual records as directors.
It may, therefore, not be enough for directors to ensure that they have satisfied their duties on an individual basis. It is incumbent upon each director to ensure that the board as a whole observes responsible principles of corporate governance, making decisions in a well informed and thoughtful manner.
The TSE Committee's Final Report recognized the risks associated with being a director in its review of corporate governance. In an attempt to permit directors to control this risk, the TSE Committee suggested that every board of directors should implement a system to enable an individual director to engage an outside advisor at the corporation's expense in appropriate circumstances. The TSE Committee recognized that individual directors may wish to dissent from a board decision, may believe that the direction the board is taking is wrong, or may otherwise be concerned about their personal liability for corporate actions and may, therefore, need to consult with independent legal, financial or other advisors. The Committee suggested that such a system should be controlled by requiring that an appropriate board committee approve any such engagement.

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(b) Unanimous Shareholder Agreements
In some cases, particularly where there is a single shareholder or very few shareholders it may be appropriate to implement a unanimous shareholder agreement to insulate the directors from certain liabilities.
A unanimous shareholder agreement is an agreement entered into by all the shareholders of a corporation under which shareholders assume some or all of the powers and responsibilities of the directors and the corresponding liabilities. The unanimous shareholder agreement does not eliminate the responsibilities and liabilities imposed on directors under the corporate statutes, but rather shifts them to the shareholders. Although a unanimous shareholder agreement is clearly impractical in a public company context, it is often put in place for wholly-owned subsidiaries of public corporations. For example, if a foreign parent corporation wishes to control the day-to-day operations of its Canadian subsidiary, it may appoint certain individuals to the board of the subsidiary in order to meet the Canadian residency requirements of that subsidiary's corporate statute. In order to protect those individuals from directors' liability in a situation in which those individuals in fact have no influence over the corporation, the parent corporation may put a unanimous shareholder agreement in place.
Directors may have reason to be concerned when they are asked to serve on the board of a corporation which is subject to an agreement, because the agreement likely does not eliminate liability under any statute other than the corporate statute and, therefore, may leave directors liable for certain actions of the corporation over which they have no control. They may, for example, retain liability for source deductions, for employee wages under provincial employment legislation or for environmental offences. For this reason, directors who agree to serve in this capacity should ensure that both the corporation and its parent provide them with a comprehensive indemnity and include them in any directors' and officers' insurance coverage carried by either corporation. Directors of the parent corporation should also be aware that the unanimous shareholder agreement may ultimately shift the liability assumed by the parent under that agreement to them.
(c) Trust Accounts and Letters of Credit
As discussed in Part III, the financial condition of the corporation will have ramifications for its directors. In some cases, it may not be possible for directors to discharge their duty to ensure that the corporation makes certain payments because the corporation is insolvent. In other cases, the insolvency of the corporation may mean that it will not be in a position to pay amounts to which the directors are entitled under their indemnities. In these situations, it may be possible for a corporation to put in place arrangements to shield directors at least to some degree. For instance, the corporation may establish trust accounts to cover liabilities for employee wages and source deductions and to support the directors' indemnities from the corporation. A letter of credit may be obtained for the same purpose.
Whether a trust account is established or a letter of credit is put in place, the obvious issue is how the trust account or letter of credit will be funded. Funds may be provided by the corporation, but if there is any question about the corporation's financial stability, that action may be subject to challenge. In one instance, a court sanctioned a trust fund prior to the corporation filing under the Companies' Creditors Arrangement Act where there was evidence that the services of the directors were required to effect a corporate reorganization. By contrast, a court refused to sanction a trust fund in similar circumstances where there was no evidence the directors would have resigned and been unavailable to assist the company with its reorganization. Another court refused to sanction a trust fund where it was clearly established on the eve of bankruptcy to limit the personal liability of directors. A third party such as a bank may be prepared to fund the trust account or letter of credit if it believes that the corporation could become viable again and wishes to ensure that capable, experienced individuals remain on the board.

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Beyond these practical issues, if the action is being taken at a time when the corporation is in a precarious financial situation, directors will need to reconcile a decision to dedicate funds to a trust account or letter of credit intended to protect the directors with their duty to act in the best interests of the corporation. While these two interests may be reconciled by noting that it is in the best interests of the corporation not to lose its entire board at a very delicate time in its existence, a challenge to such action on the basis of a breach of the directors' fiduciary duty could nevertheless be expected. Action of this nature is better considered at a time when the corporation is not in financial difficulty, perhaps at the same time as the board turns its mind to indemnities and directors' and officers' insurance. Individual directors might consider raising these issues before agreeing to serve on a board. The practical reality may be, however, that where there are no storm clouds on the horizon, directors will be unlikely to devote corporate assets to trust accounts or letters of credit which will only be required in a situation which at present seems remote.
(d) Resignation
In spite of the best efforts of a director, situations may arise in which the only means of avoiding personal liability is to resign from the board. This may be the case where there is a risk that certain statutory requirements cannot be met, for example, if the corporation is insolvent and cannot meet its obligations to its employees. In certain recent highly publicized cases, entire boards have resigned. Directors should note that their resignations do not absolve them of responsibility for any actions taken before their resignations. It only protects them from exposure to any liability for events after they resign.
The Ontario Business Corporations Act has recently been amended to deal with the situation in which an entire board resigns. The Act now provides that any person who manages the corporation will be deemed to be a director and, thus, have all the directors' duties and responsibilities. Included in exception to this deeming provision is an officer who manages the corporation under the direction of a shareholder or other person and a lawyer, accountant or other professional who participates in the management solely to provide professional services.
2. Indemnities
One of the principal means of shifting risk away from directors is by way of an indemnity. The corporate statutes in Canada permit a corporation to indemnify its directors, both past and present, in virtually any circumstance in which the directors have acted in good faith with a view to the best interests of the corporation. In some instances, these statutes actually require the corporation to indemnify its directors. The statutes also permit directors to be indemnified by a corporate shareholder or creditor which appointed them to the board.
(a) Limitations
In considering the potential scope of the corporation's indemnity, four caveats must be noted. The first is that the indemnities permitted by the corporate statutes are limited largely to indemnities for negligence. No indemnity will cover a breach of a director's fiduciary duty. Where a director fails to act honestly and in good faith with a view to the best interests of the corporation, the corporation is prohibited by statute from indemnifying the director. The limited litigation to date suggests that, in the absence of actual deceit or fraud, most directors will satisfy the honesty and good faith aspects of this test. Of greater concern is whether the director has acted in the best interests of the corporation. The most common breach of fiduciary duty dealt with in the case law disallowing indemnities is the misappropriation of corporate opportunities. In one case where a director acted specifically on the directions of the controlling shareholder, the court decided that the director did not act in the best interests of the corporation and was, therefore, not entitled to an indemnity.

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The second caveat is that a corporation which is suing a director may not indemnify the director without the approval of the court and may not, in any event, indemnify the director for an amount paid by the director to settle the action or satisfy the judgment. This is most likely to arise in a derivative action where a shareholder or creditor has sued the director on behalf of the corporation. The availability of an indemnity for judgments against directors in derivative actions is not clear, and it is likely that a corporation may not indemnify a director for a judgment awarded against the director in such circumstances. This is based on the argument that the corporation would be reimbursing directors for amounts which directors were required to pay to the corporation. In this and other circumstances in which the corporation is not certain whether it is permitted by statute to provide an indemnity to its directors, the corporate statutes allow the corporation � or a director � to apply to court for an order approving the indemnity. In that circumstance, the court may not only approve the indemnity, but may make any other order it thinks fit.
The third caveat is that a corporation is permitted to indemnify the director for fines in criminal or administrative proceedings only if the director had reasonable grounds for believing that the impugned conduct was lawful. Moreover, even if the director did have reasonable grounds for believing the conduct was lawful, it is conceivable that a court could strike down the indemnity as being contrary to public policy, since the punitive effect of the fine is lost if the director is not required to pay it. In the Bata decision, the court's decision specifically prohibited a corporation (which was subject to a separate fine) from indemnifying its directors for fines assessed for breach of an environmental statute. The court did not find that such indemnities were contrary to public policy, but one might anticipate that if the legislators' intention is to punish directors, courts may continue to insist in future that the corporation not indemnify directors in such circumstances. The only alternative punishment, as the court noted, would be to impose a sentence of imprisonment. The treatment of the indemnity issue in the Bata decision was upheld at the first level of appeal and that decision is now under appeal.
The final caveat is that an indemnity is only as good as the corporation's ability to honour it. An insolvent company will likely not be in a position to indemnify its directors, and directors entitled to an indemnity which the corporation is unable to pay will be unsecured creditors of the corporation. An indemnity from a parent corporation or major shareholder may assist in this regard.
(b) Tax Treatment
An issue of concern to directors is the income tax treatment of an indemnity payment they receive from the corporation. Revenue Canada's administrative practice is generally that indemnification of a corporate director will not give rise to a taxable benefit for that director, provided that such indemnification meets the requirements of the corporation's statutes. Revenue Canada's administrative practice is further that where a corporation purchases liability insurance for its directors and the risks covered by the policies are inherent and normal occurrences in carrying out the duties of the insured as a director, neither the premiums paid under the policy nor any proceeds that may be payable under the policy will generally be considered a taxable benefit to the directors. While these administrative practices are not binding on Revenue Canada as a matter of law, they provide useful practical guidance as to Revenue Canada's likely assessing practice on audit.
(c) Mandatory Indemnity
Corporations are required by statute to indemnify their directors in certain circumstances. This mandatory indemnity extends to past and present directors of the corporation and any person who at the corporation's request acts as a director of another entity of which the corporation is a shareholder or creditor.

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Where a director acts honestly, in good faith and with a view to the best interests of the corporation, the corporation is required to indemnify the director for all costs relating to litigation in which the director was involved as a result of having been a director, subject to the additional condition that the director must have been substantially successful on the merits in defending the action or proceeding. The mandatory indemnity would cover common law actions against directors by third parties, as well as civil liability imposed on directors under securities legislation or corporate statutes.
There are a number of costs and expenses which may not be covered by the mandatory indemnity. For example, there is no clear statutory requirement for a corporation to indemnify directors for amounts they are required to pay to settle an action or satisfy a judgment, and the mandatory indemnity may not extend to cover expenses incurred by a director in connection with an investigation which did not proceed to litigation. It is, of course, open to the corporation to reimburse the director, either voluntarily or through a separate indemnity under contract or in the by-laws, for such costs and expenses, subject to the limitations discussed above.
(d) Indemnities Contained in By-laws
Indemnities contained in by-laws usually repeat the statutory provisions describing the indemnity which corporations are permitted to extend to their directors. These indemnities may not be appropriate in all circumstances. In some jurisdictions, where a corporation contravenes its by-laws a director may apply to the court for an order directing the corporation to comply with a by-law. In jurisdictions where this is not permitted, a director may be in a better position with a contractual indemnity which the director may enforce against the corporation, unless the director can argue successfully that the indemnity terms of the by-law are indicative of a separate oral contract. In addition, a contract between a corporation and a director can only be amended by the agreement of those two parties, while the by-laws of a corporation can be amended over the objections of an individual director. Finally, since by-laws normally include the language of the corporate statute, there may be little opportunity for the corporation, the directors or their counsel to improve on the words of the statute to clarify the scope of the indemnity or to customize it to suit the corporation's particular circumstances. Examples of improvements which may be made on the statutory scheme are set out below.
(e) Contractual Indemnities
Many corporations provide separate contractual indemnities for their directors in substitution for or in addition to any indemnities contained in the by-laws. From a director's perspective, the terms of any contractual indemnity with a corporation should be as broad as possible and should require the corporation to indemnify the director fully, regardless of any limitations in the corporation's insurance, such as deductibles and policy limits. The indemnity should extend to all claims and should cover acts and omissions of the director as well as acts and omissions of the corporation for which the director may be vicariously liable. Typically, an indemnity will explicitly exclude a claim if directors have been found, by the express terms of a final judgment, grossly negligent or to have wilfully misconducted themselves in the performance of their duty to the corporation. A director should ensure that any such exclusion is tied to an objective standard, such as a finding by a court or tribunal that the director was grossly negligent. Otherwise, the standard may become the subject of dispute if the corporation does not wish to honour the indemnity.
Directors should also ensure that the indemnity requires the corporation to indemnify them immediately, and not, for example, after insurance proceeds are paid to the corporation. The indemnity should also include agreement by the corporation to maintain directors' and officers' insurance, to provide the directors with a copy of the policy, to keep the insurance in place for a specified

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Once the decision has been made to acquire insurance, it is important that the application form be completed accurately. The statements made in the application are considered to be warranties and a breach of those warranties may lead to a loss of certain coverage or the voiding of the entire policy. Directors may wish to consider reviewing the application before it is submitted to the insurer.
(b) Terms of the Policy
Directors' and officers' insurance typically covers both the corporation (to reimburse it if it is required to pay indemnities) and the directors and officers (to indemnify them directly) under a single premium, although the premium can be allocated between the two types of coverage. Under the corporate reimbursement portion of the policy, the corporation is covered for any amounts paid to indemnify its officers and directors other than any indemnification prohibited by the corporate statutes. If the directors themselves pay the premium for the part of the policy which will cover them personally, the policy may be able to cover more than the types of losses for which the corporate statutes permit the corporation to carry insurance. Directors' and officers' personal coverage covers directors and officers directly where the corporation chooses not to, or is unable to, indemnify the officers or directors. However, directors should note that since the policy is between the insurer and the corporation, they will not necessarily be notified if the policy is cancelled, unless the policy specifies such notice.
As with any insurance policy, a careful review of the specific terms is necessary, since the coverage from one insurer to another can vary dramatically. Standard form policies can be tailored to suit the particular needs of the corporation, often for an additional premium. Advice should be sought from the corporation's officers responsible for risk management or from an insurance broker. The corporation's legal advisors may be consulted to determine what types of risks should be addressed.
The first issue to consider is who will be covered by the policy and in what capacity. Directors and officers should be covered, both during their tenure and for a period of time after they cease to hold office. Since most liabilities expire a number of years after an individual ceases to be a director, the policy should extend beyond the date on which directors and officers cease to hold office, cost permitting. Advice should be sought about the period of time appropriate to the particular corporation. The directors and officers of the corporation's subsidiaries should also be covered. If the corporation asks its employees to sit on boards of other corporations, such as those in which the corporation has made an investment, the board may consider extending the policy to those persons.
The "wrongful acts" which are covered by a policy are normally quite broad and include: any actual or alleged error or misstatement or misleading statement; any act, omission, neglect or breach of duty by the directors individually or collectively; and any other matter (other than one which is specifically excluded) claimed against a director solely by reason of being a director. The definition of "loss" is also important and should be carefully reviewed by directors or their advisors. Does the policy cover settlements or only damages and judgments? Will preliminary investigations by a regulatory body such as a securities commission be covered, or is coverage limited to formal proceedings only or to situations where charges have been laid? Most importantly, perhaps, are all statutory liabilities covered? Particularly important is coverage for the "absolute liabilities" discussed in Part IV, such as liability for employee wages and vacation pay under certain statutes, since directors will not always be able to prevent a situation from arising in which they would incur such liability.
A number of exclusions which are typical of most policies are identical to the exclusions under indemnities. Often, insurance will exclude claims arising from the dishonesty of a director or from derivative actions where the director received a direct benefit as a result of using inside information. As in the discussion about indemnities,

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any exclusion for dishonesty should apply only where dishonesty is proven, preferably on the criminal standard of proof beyond a reasonable doubt. Most insurance will not cover claims in actions where the directors obtained a personal profit or advantage to which they were not legally entitled. Some policies cover derivative actions, but not actions commenced by the corporation itself against the directors. A policy will often cover judgments, settlements and investigative and legal costs, but not fines or penalties imposed by law, punitive or exemplary damages or matters which the law may determine to be uninsurable.
Other common exclusions are often covered by contractual indemnities. For example, many policies will not cover claims arising out of pollution incidents or claims made by principal shareholders of the corporation. Directors should ensure that they are aware of any special endorsements in the insurance policy which would limit the directors' coverage in high-risk areas associated with the corporation's business, because these may be precisely the areas in which the directors require insurance. Where the corporation's business involves particular risks, coverage beyond the standard coverage may be advisable and may be available for an additional premium. However, if there is no concern about the ability of the corporation to honour its indemnity to the directors, the premium payable with respect to high-risk areas may not be warranted.
Directors should note that the policy in all probability only covers directors and officers "acting in their capacity as directors or officers". If a director also has some other relationship to the corporation � for example, as an advisor to the corporation � the policy will likely not cover the director if the claim relates to an incident in which that person was acting as advisor. The delineation of roles may not always be clear and may be a source of disagreement between the insured and the insurer.

Directors should be aware that policies are very often written on a "claims made" basis and will not cover those claims made outside the policy period, even though the event which gave rise to the claim occurred during the policy period. If the claim is not made until after the expiry of the policy, the director will not be insured. A "discovery clause" might be preferable because it protects the insured for all occurrences during the policy period and for a specified period after the policy has been cancelled or has expired. It may also be desirable to include an "extended reporting period" clause that provides that if the insurer terminates or refuses to renew the policy, the corporation or its directors may, upon payment of a specified premium, extend the coverage for a specified period for claims arising out of "wrongful acts" attempted or committed before the effective date of termination. Directors should also ensure that they will be covered after they cease to be directors for incidents which occurred while they were directors.
Consideration should also be given to how much a policy will pay when a claim is made. Directors may wish to ensure that their indemnity with the corporation covers any deductible. Insurance may include a co-insurance provision, whereby the policy does not cover the entire loss, but only a certain percentage of any loss in excess of any deductible. Directors may be content to rely on the indemnity with the corporation to cover them for the remainder, but they should do so only on an informed basis. Any policy will have a limit, likely the aggregate liability for each policy year rather than liability for each individual claim. If the directors seek to rely on insurance when they become liable as a result of a significant occurrence such as an environmental accident they will probably find that the insurance proceeds are insufficient to cover their exposure.
Defence coverage is another issue which directors should consider. This aspect may be dealt with in one of two ways. "Duty to defend" coverage requires the insurer to provide a defence for the director. "Defence expense" provides for reimbursement of defence expenses incurred by the insured. This latter type of coverage gives the

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directors the ability to retain defence counsel of their own choice (normally subject to the consent of the insurer) and to control the defence of the action, and is the more usual clause in modern policies.
Settlement coverage should also be considered. Since most claims against directors are settled before trial, the scope of coverage provided for settlement is particularly important. The policy may provide that no settlements shall be made without the insurer's consent and that the insurer will not be liable for any settlements to which it has not consented.
Geographic scope may be an issue if the corporation carries on business outside Canada. The policy should also be reviewed to ensure that coverage is available for claims made outside Canada.
Once the insurance is in place, directors must ensure that the necessary action is taken to keep the insurance in good standing and to make claims under the policy as appropriate. Payment of premiums when due is an obvious measure, but directors will not necessarily know if the corporation has stopped paying premiums or if the policy has been terminated for any other reason. It is important to be aware of the time frame within which claims must be reported in order for the corporation and the directors to get the greatest possible benefit from the policy. Directors should advise the corporation's risk manager on a timely basis of any claims of which they become aware. It is equally important that directors advise the risk manager of any circumstances which could give rise to a claim as soon as they become aware of such circumstances. This is particularly important if the corporation's policy includes a provision which covers any claims reported during the policy period even after the policy period has expired.
4. When an Action is Brought
Directors who are named in a lawsuit or who are subject to investigation in their capacity as directors should consult independent counsel. When directors plan to enforce an indemnity against the corporation, the interests of the corporation and the directors may diverge, and the directors should seek advice from someone other than the corporation's counsel. For example, the corporation may take the position that costs incurred by a director in connection with an investigation by police or a regulatory authority where no charges are ultimately laid may not be covered by the mandatory statutory indemnity. There may be some questions about whether such costs are covered by any separate indemnity or insurance and directors will need to ensure that their interests are protected.

he essence of director responsibility is the duty to act honestly, in a diligent manner, in good faith and in the best interests of the corporation. Layered on top of this duty are a host of statutory and regulatory obligations imposed on directors to ensure accountability and to promote social goals. These legal obligations are intended to shape the way in which directors discharge their duties. Directors who are well versed in the scope of their responsibilities will be in a position to discharge their duties in a manner that limits the extent of their potential liability. In addition, directors may be able to shift potential risk through the use of indemnities and insurance, although neither of these will cover a breach of a director's duty to act in good faith and in the best interests of the corporation.
As a result of the current focus on directors' duties, it is incumbent upon those who act as directors to be aware of their duties and to understand the ramifications of failing to discharge them adequately. In agreeing to serve as a director, an individual makes a commitment to devote sufficient time to be able to act in good faith, in an informed manner and in the best interests of the corporation. Discharging these obligations will usually mean being prepared to ask difficult questions and to make difficult decisions.

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The following is a list of certain considerations which will help directors to minimize the risk associated with sitting on a board:
€ On being invited to join a board, individuals should inform themselves about the nature of the corporation's business and satisfy themselves that the corporation and the board function in a way which allows the directors to fully discharge their responsibilities.
€ Directors must understand thoroughly their duties and responsibilities and the liabilities and penalties associated with failing to discharge those duties and responsibilities.
€ Directors must act honestly and in good faith with a view to the best interests of the corporation and apply care, diligence and skill in discharging their responsibilities.
€ Directors must prevent their own interests from conflicting with, or appearing to conflict with, the interests of the corporation.
€ The appointment of the chief executive officer and other members of senior management and the relationship of management to the board are critical. The board must have confidence in these individuals and in their willingness to keep the board informed.
€ The board must have sufficient information to allow it to reach informed decisions. The information must be detailed enough to give the directors the complete picture, but not so detailed that the directors cannot absorb it. The information must be provided far enough in advance of board meetings to allow directors time to review and consider it. Directors must not misuse confidential information.
€ Directors should avoid missing meetings of the board, but where this is unavoidable, they should inform themselves about what occurred and have their dissent recorded if they disagree with any action taken at that meeting.

€ The board should delegate to committees when appropriate. For example, environmental committees are common. Directors who serve on a committee should be aware that their exposure to liability may increase with respect to matters within the mandate of that committee.
€ Appropriate reporting requirements should also be put in place. For example, directors should require the corporation's chief financial officer to provide assurance at appropriate intervals that all employee wages have been paid and all source deductions have been deducted and remitted as they became due.
€ Appropriate audit and other review procedures should be put in place to ensure compliance with all legal requirements imposed on the corporation and its directors. As examples, this guide details some of the procedures applicable to the preparation of a prospectus and to environmental compliance.
€ The board should consider consulting outside advisors in appropriate circumstances, particularly whenever the corporation proposes a major transaction such as an acquisition, divestiture, reorganization or financing.
€ Directors must be satisfied that reliance on the corporation's financial statements, its officers or outside advisors is warranted.
€ Directors should obtain an indemnity from the corporation and, where appropriate, from the parent corporation or major shareholder. A contractual indemnity should be used to complement one contained in the by-laws of the corporation.
€ The board should consider purchasing directors' and officers' insurance. The board must weigh the cost of insurance against the need to put insurance in place to attract and retain high quality directors. Directors should be aware of the limitations of any policy which is put in place.

This article is necessarily of a general nature and cannot be regarded as legal advice. Upon request, members of the firm would be pleased to provide additional details and to discuss the possible effects of matters contained in this article in specific situations.

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