By: Robert Stack. May 9, 2020
Difficult economic times like we are facing now present huge challenges and risks for the people who run public companies. Boards and management must apply complex rules, such as Generally Accepted Accounting Principles (“GAAP”), in times of great uncertainty and change. The decisions of directors and officers may come under scrutiny from regulators, investors or court-appointed trustees.
It is therefore a good time for directors and officers to brush up on potential areas of liability. This short refresher will look at three areas in which directors and officers may face liability in the covid-19 environment — employment, securities law and insolvency.
Directors can be liable for unpaid wages to employees under both business corporation legislation and employment standards laws across Canada. In Alberta, the relevant provisions are s. 119 of the Business Corporations Act, RSA 2000, c B-9 (“ABCA”) and s. 112 of the Employment Standards Code, RSA 2000, c E-9 (“ESC”).
While the Director of Employment Standards may initiate proceedings under s. 112 of the ESC, an employee can seek recovery privately under the ABCA. Both statutes state a director can avoid liability by showing she had reason to believe that the corporation could pay its debts to employees as they came due. Under the ABCA, a plaintiff employee has to first sue and seek recovery from the corporation before proceeding against the director for any unsatisfied amount. Plaintiffs may need some liquidity, therefore, to pursue these claims.
Several pieces of Federal legislation make directors liable for the failure of an employer to withhold and remit source deductions. These provisions also include due diligence defences and require CRA to proceed first against the company before seeking to collect from directors.
A provision in the Occupational Health and Safety Act, SA 2017, c O-2.1 that directors may want to be aware of in the coming months is s. 1(n), which defines “employer” to include “a director or officer of a corporation…” Directors in this environment should ask tough questions of management to ensure that only those who can be paid are asked to work, deductions are remitted and OHS requirements are met.
Securities Compliance and Financial Disclosure Liability
Most securities regulations are aimed at entities that issue securities, such as corporations, and intermediaries that are involved in trading securities. However, directors and officers of issuers and trading firms can be personally responsible for violations of securities laws by the entities they govern.
In Alberta, s. 198(1.2) of the Securities Act, RSA 2000, c S-4 (“ASA”), states that an officer or director who “authorizes, permits or acquiesces in the contravention of Alberta securities laws” by an entity can be subject to an administrative order prohibiting a host of business activities, including trading in securities and acting as an officer or director. S. 199 of the ASA permits administrative fines against directors and officers who authorize or permit violations by corporations. Further, s. 194(3) of the ASA allows a court to sentence an officer or director to up to 5 years less a day of imprisonment for authorizing or directing a violation of securities laws by a corporation. Similar provisions exist in other securities legislation throughout Canada.
Directors and officers can also face civil liability, both under securities legislation and in tort law, for false or misleading statements that a company may make in a prospectus, offering memorandum or circular. Directors and officers may be the target of derivative or creditor actions in relation to financial reporting. When the liability of the company is fairly clear in such cases, the issue for plaintiffs becomes proving why certain officers or directors should be personally liable, while directors or officers may want to show they acted diligently or had little control over or responsibility for the transaction or representation in question.
Perhaps the biggest area of risk for directors and officers in the coming months will be ongoing financial disclosure required by securities laws. The financial statements companies publish have to be consistent with GAAP rules, which are complex. Directors may feel they have limited information about financial matters in a company, while the liability exposure of CEOs and CFOs is heightened by the fact they have to certify personally the issuer’s public disclosure. Severe supply chain challenges, rapid changes in credit risk, the potential frustration of material contracts, the timing of “going concern” warnings – such issues will challenge the judgement of boards and officers in the coming months.
Directors and officers will want to be cautious, seek legal and accounting advice – and expect scrutiny.
Tightening cashflows and deteriorating balance sheets cause a range of problems for directors. Insolvency proceedings can be both a source of liability and protection for the people who manage and direct companies. Similarly, they can be a source of compensation or an obstacle to those seeking to recover losses.
Under s. 101 of the Bankruptcy and Insolvency Act, RSC 1985, c B-3 (“BIA”), a court can examine dividends, redemptions and various kinds of payments to directors that occurred in the year before the bankruptcy to determine if the transaction rendered the corporation insolvent or happened when the company was already insolvent. Directors may be liable to the trustee for such transactions, unless they can show the company was not insolvent at the time, or they had sufficient reason to think it was not, or that the compensation to the director in question was not “conspicuously” over fair market value.
Similarly, under s. 96 of the BIA, directors and officers can be liable to the estate for “transfers undervalue” preceding the bankruptcy where they receive a direct or indirect benefit. Creditors can initiate their own proceedings in relation to transactions they view as intended to defeat their claims, citing provincial fraudulent preference legislation or the oppression remedy sections of statues such as the ABCA. Directors may be named in such actions for receiving benefits from the transaction, breach of fiduciary duty or oppression of creditor interests.
At the same time, stay protections under both the BIA and the Companies’ Creditors Arrangement Act, RSC 1985, c C-36 (“CCAA”) may extend to directors. Claims against directors may also be dealt with conclusively in BIA proposals and CCAA compromises. There are exceptions for obligations relating to personal guarantees and claims of misrepresentation and oppressive or wrongful conduct by directors. The scope of those exceptions could be the subject of considerable litigation in the coming months.
Directors and officers, or their insurers or counsel, will want to monitor closely insolvency proceedings and seek to have adverse claims resolved within them. Plaintiffs may have to make strategic decisions about whether their chances of recovery are better within an insolvency proceeding or outside of it.
Help for Directors & Officers
Proactive and practical measures can go a long way towards protecting directors and officers from personal liability. In general, directors and officers may want to seek independent legal advice to ensure their interests are protected. First steps may include a discussion of current concerns and risks and a review of indemnification agreements and D&O insurance policies.
Wilson Laycraft has extensive experience in civil and regulatory matters involving directors and officer liability. We also act for creditors and investors seeking recovery in a variety of circumstances. If you or a client you represent are potentially at risk, give us a call to discuss the options. We are here to help.
For details about the author: www.wilcraft.com/who-we-are/robert-stack/