Becoming a Corporate Director – The Responsiblities and the Risks
In Canada, companies can be incorporated at either the federal or provincial level, and at either level, incorporation offers many advantages. Corporations have a separate legal existence from their shareholder owners, and therefore provide those owners with protection from liability for actions or negligence of the corporation.
There are also tax advantages to incorporation, as corporate tax rates, especially for smaller businesses, are generally lower than those imposed on individuals. As well, incorporation provides the business with a continuous existence and allows the business to be owned by more than one individual—a benefit for a sole proprietor or the partners who want to pass the business on to the next generation.
Whether the incorporation is federal or provincial, and whatever the reason for incorporating a business or the kind of business it is, the rules governing the structure and operation of that corporation are largely the same. And one of the invariable rules requires every corporation—large or small—to have a least one director.
Who can be a corporate director?
Each corporation can choose the number of directors who sit on its board (or, more typically, can set a minimum and maximum number of directors) and that number, along with other details of the corporate structure, are outlined in the company’s Articles of Incorporation. While it’s possible to have just a single director, this would usually be the case only for the smallest of companies.
To become a corporate director, a person (and it must be a person—a corporation cannot be a corporate director) must be at least 18 years of age, must be of sound mind (that is, must not have been declared incompetent by a court), and must not be currently in bankruptcy. It’s not actually necessary for a director of a Canadian corporation to be a Canadian, but the rules require that at least 25% of the directors of any Canadian corporation be Canadian residents. Where a corporate board of directors has fewer than three members, at least one of those directors must be a Canadian resident. Directors can be elected for terms of up to three years, but where the corporation’s governing documents don’t specify a fixed term, a director holds his or her position until the next meeting of the shareholders of the company, at which time he or she may be reelected. Shareholders’ meetings are held annually.
Finally, the law does not actually require that a director own shares of the company on whose board he or she sits. The company can, however, require directors to own corporate shares as a precondition to holding a position on the board.
First Board of Directors
When a business applies to Corporations Canada for a certificate of incorporation, it must provide both the Articles of Incorporation for the new company and a First Board of Directors form.
The First Board of Directors form lists the names and addresses of the initial members of the board of directors of the corporation, and indicates whether each of them is a Canadian resident. The responsibilities of these directors begin on the date Corporations Canada issues the Certificate of Incorporation for the new company and ends at the first meeting of shareholders, when the shareholders elect the corporation’s directors. Elected directors may be chosen from the first directors or one or more of those directors can be replaced.
The responsibilities of corporate directors
Directors are responsible for the overall governance of the company. While they are not typically involved in the day-to-day management of company business, they appoint and oversee the corporate officers (the chief executive officer, chief financial officer, etc.) who do make the important day-to-day decisions. As well, directors of a company have the power to make significant changes affecting the structure and direction of the company, and many of those decisions can be made with no need for approval by the shareholders. For instance, a company’s board of directors can approve financial statements of the business and can change the company’s by-laws and Articles of Incorporation, which determine the corporation’s structure and the rules which govern the operation of the corporation. By-law changes must ultimately be approved by the company’s shareholders at the next regular shareholders’ meeting.
The authority which directors possess over the conduct of corporate affairs is matched by the responsibility they bear for actions taken by the company. In general, the directors have what is termed a “fiduciary” duty toward the company. In practical terms, having such a duty requires the directors to put the interests of the company above their own. For instance, where there is a business opportunity available to the company, any of the directors of that company are precluded from pursuing that business opportunity for their own benefit or that of another company.
Overall, directors are expected to act honestly and in the best interests of the company, and to exercise at least the level of care and diligence that a reasonable person would exercise in similar circumstances.
While directors are ultimately responsible for all facets of company operations, there are some areas which cause more difficulties for directors than others. The one which most often results in personal liability for directors is the obligations which the company owes to the Canada Revenue Agency (CRA).
What is a director’s potential liability?
A company, depending on its size and the industry in which it operates, can have a variety of legal and tax obligations, with the latter usually including the obligation to remit amounts on a regular basis to the federal government. Again, depending on the industry and activities of the corporation, those remittance obligations can involve excise duty, refundable tax for scientific research and experimental development, or share-purchase tax credits or payments to non-residents. Corporate directors can be held liable for a company’s failure to remit any or all such amounts. However the one remittance obligation common to virtually all companies is that of remittance of employee source deductions. Any corporation which has employees must withhold income tax, Canada Pension Plan contributions, and Employment Insurance premiums from the employees’ wages, and must remit those amounts, together with any required employer contribution, to the CRA on a regular basis. It’s not surprising, therefore, that the majority of cases in which directors have been held personally liable for a corporation’s failure to remit have involved employee source deductions. And, when a failure to withhold or remit source deductions has occurred, the obligations of directors generally come down to the following four questions.
- Who can be held liable?
- What can they be held liable for?
- How can liability be avoided?
- What are the potential consequences where liability is established?
Who is a corporate director?
Given the detailed requirements the law imposes for the appointment and election of directors, it may seem odd to ask who is a corporate director. However, it’s possible for someone to be held liable for corporate obligations even when that person has never actually been elected to sit on the Board of Directors.
In the CRA’s view, the net of potential directors’ liability is cast very, very broadly. Or, in the CRA’s wording, “[T]he statutes do not distinguish between directors, whether active, passive, nominee or outside directors.” Anyone who holds the title of director can face personal liability for the company’s failure to fulfill its obligations to the CRA.
It’s a common misconception that a director who is not involved in the affairs of the company—who doesn’t, for instance, attend directors’ meetings, read minutes of the meetings, or sign directors’ resolutions—can’t be held liable for decisions made at meetings he or she didn’t attend or implemented through resolutions of which he or she was unaware. In fact, the opposite is true—not only does a lack in involvement in the affairs of the company generally not absolve a director of potential liability, that very lack of involvement can be seen as evidence of a failure to meet the obligations that come with a position as a company director. And, finally, it’s not even necessary to formally hold a position as director in order to be held liable for company failures. The CRA’s position is that “[O]fficers, employees and others who are not legally appointed or elected as directors, but who perform the functions that directors would perform, may be liable.”
Directors’ and officers’ insurance
A few decades ago, a position on a company’s board of directors was seen as something of a sinecure—a job which required little actual work but for which the compensation could be quite generous. A number of changes over the past decade or so have changed that perception. Several high profile corporate bankruptcies and/or frauds, and the resulting losses sustained by shareholders, employees (past and present), and corporate creditors have led to a renewed focus on the responsibilities of directors and the extent to which they fulfill those responsibilities. As well, a new level of shareholder activism has meant that, more than ever, directors are being held to account where wrongdoing or negligence by corporate officers has been shown to have taken place on the directors’ watch.
One of the by-products of that increased scrutiny and potential liability has been a greater reluctance by qualified individuals to become corporate directors, or at least a desire on their part to seek assurances that measures have been put in place to protect them from certain liabilities. The corporation is entitled to provide such assurances, which may include one or more of the following measures identified by Corporations Canada:
- purchasing insurance to protect directors and officers against liabilities incurred in the exercise of their duties;
- agreeing to compensate directors and officers for losses they may suffer or costs they may incur while carrying out their duties—except where the director or officer has failed to act honestly and in the corporation’s best interests; or
- in certain circumstances, advancing funds to directors and officers to help them pay the costs of defending themselves in legal actions brought against them. Note, however, that in cases where directors or officers fail to defend themselves successfully, they are required to repay the corporation for these advances.
The articles posted here provide information of a general nature. These articles should not be considered specific advice; as each vistor’s personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in these articles.
Content provided by CCH Wolters Kluwer
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