Personal liability of a director - are you at risk?
Market Insight 02 November 2017 02 November 2017
If a director of a corporation acts in an oppressive or unfairly prejudicial way toward certain classes of parties involved in the corporation, he or she can be held personally liable under the federal and provincial corporate statutes (Canada Business Corporations Act, RSC 1985, c. C-44 (“CBCA”); British Columbia’s Business Corporations Act, SBC 2000, c 57).
Oppressive conduct occurs when a director makes a decision on behalf of the company that unfairly and negatively impacts the interests of the company’s stakeholders, such as other directors, officers, shareholders and creditors. When a director exercises control improperly, or otherwise “oppresses” the other parties’ interests by denying them an expected benefit from the company, the director may be personally liable to remedy that breach.
Directors and officers should be aware of their potential exposure to personal liability. A recent Supreme Court of Canada case, Wilson v. Alharayeri, 2017 SCC 39, has reviewed section 241 of the CBCA, which stipulates that a director may be found personally liable for oppressive or prejudicial conduct. The four principles articulated in the case (discussed below) serve as a guide to the flexible and discretionary approach that courts have adopted in assessing whether oppressive conduct occurred.
Wilson v. Alharayeri arose from the following facts:
- The corporation issued a private placement, meaning that they sold shares directly to private investors, rather than as part of a public offering.
- The private placement substantially diluted the proportion of common shares held by the corporation’s shareholders who did not participate in the placement.
- Prior to issuing the private placement, the board of directors refused the plaintiff-shareholder’s request to convert his shares from preferred to common shares.
- This is even though the plaintiff-shareholder’s shares were convertible based on the articles of incorporation and the corporation’s financial statements.
- Rather, the board of directors chose to convert the shares held by the CEO.
- The conversion of the CEO’s shares occurred despite doubts expressed by the corporation’s auditors as to whether the test to convert these shares into common shares had been met.
- As a result of the private placement, the plaintiff-shareholder’s proportion of common shares and their value was significantly reduced.
- The trial court found that the CEO and the chairperson of the audit committee, who were both directors, were personally liable to the plaintiff-shareholder for the directors’ refusal to convert the shareholder’s shares into common shares.
- The trial court found that the directors failed to ensure that the plaintiff-shareholder’s rights were not prejudiced by the initial share sale.
- Both directors had used their influence, as the only audit committee members, to advocate against the conversion of the plaintiff-shareholder’s shares.
The principal question raised by the appeal was, “When may an order for compensation under section 241 of the CBCA properly lie against the directors of a corporation personally, as opposed to against the corporation itself?” The Supreme Court of Canada unanimously dismissed the directors’ appeal, and upheld the conclusion that the directors were personally liable to the oppressed shareholder.
The Court confirmed that it has extremely broad powers in the face of corporate oppression, given that the CBCA allows “a court to make any interim or final order it thinks fit” in order to “rectify the matters complained of in an action for corporate oppression.”
The Court further confirmed that the principles articulated nearly 20 years ago by the Court of Appeal of Ontario in Budd v. Gentra Inc. (1998), 43 BLR (2d) 27, remain applicable. This case provides for a two-pronged approach to personal liability. The first prong requires that the oppressive conduct be properly attributable to the director because he or she is associated with the oppression. In other words, the director must have exercised – or neglected to have exercised – his or her powers so as to cause the oppressive conduct. This first requirement alone is an inadequate basis for holding a director personally liable.
The second prong requires that the finding of personal liability be appropriate in all of the circumstances. The case law has set forth several general principles that should guide courts in considering whether it is appropriate to find a director personally liable in the circumstances. Specifically, an oppressive remedy must:
- be fair in the circumstances;
- go no further than what is necessary to rectify the oppression;
- comply with the reasonable expectations of the corporate stakeholders; and
- be appropriate in light of other corporate law remedies available.
In considering the first principle, the oppression remedy must be fair. For instance, where a director has derived a personal benefit, in the form of either an immediate financial advantage or increased control of the corporation, an order against the director personally will tend to be fair. Similarly, where a director has breached a personal duty owed as a director or has misused a corporate power, it may be fair to impose personal liability. Where a remedy against the corporation would unduly prejudice other security holders, this too may weigh in favour of personal liability.
Notably, neither a personal benefit nor bad faith is a necessary condition for a finding of personal liability. Gaining a personal benefit and acting in bad faith remain hallmarks of conduct properly attracting personal liability. Although the possibility of personal liability in the absence of both of these elements is not foreclosed, one of them will typically be present in cases in which it is fair and fit to hold a director personally liable for oppressive corporate conduct.
The second principle maintains that an order made under section 241(3) of the CBCA should go no further than necessary to rectify the oppression. This follows from the provision’s remedial purpose, with the intent to correct the injustice between the parties.
The third principle maintains that any oppressive remedy ordered may serve only to assert the reasonable expectations of corporate stakeholders, such as creditors, shareholders, other directors and officers, security holders, employees involved in the ownership, etc. This remedy recognizes that behind a corporation there are individuals with rights, expectations and obligations, who are not necessarily or directly part of the company structure. However, the remedy protects only those expectations stemming from a person’s status as a corporate stakeholder. As an example, a manager who has an ownership interest in the company is considered a corporate stakeholder. The courts will likely protect the manager’s rights in the event that a director makes a corporate decision that unfairly and negatively affects the manager’s ownership share.
Remedial orders may not defend expectations arising merely by virtue of a personal relationship. Also, such orders cannot serve a purely tactical purpose, nor can a complainant be allowed to “skip the creditors’ line” by seeking relief against a director personally.
Finally, the fourth principle ensures that statutory oppression is not the only remedy available. A director’s personal liability should not be a replacement for other forms of statutory or common law relief, particularly where such other relief may be more fitting in the circumstances.
Interestingly, where a court concludes that it is appropriate to impose personal liability, it can find that both the corporation and the directors are liable. For example, in the case of Wood Estate, 2016 ONSC 36, a shareholder made a short-term loan to the corporation with the reasonable expectation that it would be repaid from the proceeds of a specific transaction. Those proceeds were instead applied to corporate purposes, as well as to the repayment of certain loans made to the corporation by the directors and by another shareholder. The Court not only found the directors liable for the amounts used to repay their own loans and the shareholder loan, but it also ordered the corporation to pay an equal amount towards the balance of the loan. The fairness principle will largely govern a court’s finding in each instance.
When it comes to the corporate oppression remedy, whether a finding of personal liability against a director is justified is dependent upon the facts of each particular case. The best protection against personal liability is for the director to ensure that he or she does not participate in corporate conduct that is oppressive, unfairly prejudicial to the interests of any of the corporation’s stakeholders, or unfairly disregards the interests of any of the corporation’s stakeholders.