Corporate directors’ conflicts of interests

Directors overriding legal obligations

Directors’ legal obligations in a conflict of interests arise out of broader legal obligations that directors owe in Canada, which includes a fiduciary duty to the corporation. Under the fiduciary duty, directors of a corporation must act honestly, in good faith, and in the best interests of the corporation. Directors also owe a duty of care. More specifically, Business Corporations Acts impose the following obligations on every director and officer of a corporation in the exercise of their powers and discharge of their duties to the corporation:

(a) to act honestly and in good faith with a view to the best interests of the corporation; and

(b) to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

Under federal and provincial Business Corporations Acts, directors also have a legal obligation to exercise their powers and manage the business of the company in a manner that is not oppressive, unfairly prejudicial to, or that unfairly disregards the interests of other stakeholders, who can be other shareholders, directors, officers or creditors of the corporation.

The obligation to disclose conflicts of interest

The Ontario Business Corporations Act (OBCA) refers to a director’s conflict of interests as follows:

(a) a party to a material contract or transaction or proposed material contract or transaction with the corporation; or

(b) a director or an officer of, or has a material interest in, any person who is a party to a material contract or transaction or proposed material contract or transaction with the corporation.

Similar provisions are contained in other Business Corporations Acts.

This can include situations where the director has or has taken advantage of a direct financial interest in a transaction (for example as a supplier or customer of the corporation), indirect financial interest (for example as a spouse of someone who owns a business that stands to benefit from a transaction with the corporation), a corporate opportunity (for example where the director takes advantage of a business opportunity that should have been offered to the corporation) or interrelated directorships (for example where the director serves on the boards of competing companies, leading to divided loyalties).

Under these statutes, a director who has a conflict of interests is required to disclose in writing to the corporation or request to have the minutes of meetings of directors confirm the nature and extent of his or her interests.

A director is required to make this disclosure at the following times:

• at the meeting at which a proposed transaction in question is first considered, or if the conflict of interests arose later, at the first meeting after the director becomes so interested;
• if the director becomes interested after a contract is made or a transaction is entered into, at the first meeting after the director becomes so interested; and
• if a person who is interested in a transaction in question later becomes a director, at the first meeting after he or she becomes a director.

Similar obligations are imposed on an officer of the corporation who has a conflict of interests.

The director must not participate in a vote to approve the transaction

A director who is in a conflict of interests must not attend a directors’ meeting that discusses the transaction in question and must not vote on it (there are limited exceptions to this rule).

The contract or transaction must be fair to the corporation

Disclosure of the conflict of interests is not always enough to protect the director, the transaction in question at the centre of the alleged conflict of interests.

Where the corporation proceeds with the contract or transaction that is at the heart of the conflict of interest, a director who complies with these disclosure obligations is still required to show that the transaction in question at the heart of the conflict of interests was reasonable and fair to the corporation at the time that it was approved. In addition, the director must show that he or she was acting honestly and in good faith in all that relates to the transaction in question.

Summary of a director’s obligations

In summary, a director has the following obligations relating to a transaction or contract in which he or she has a conflict of interest:

1. The director must disclose the nature and extent of the conflict of interests to the corporation in writing or by requesting that their conflict of interests be recorded in directors’ meeting minutes.
2. The director must make this disclosure as soon as he or she becomes or should become aware of it.
3. The director must not vote on any resolution involving a transaction that involves the conflicting interests.
4. In some provinces, the director must not even attend a directors’ meeting that discusses the transaction.
5. The transaction must be reasonable and fair to the corporation.
6. The director must act honestly and in good faith in all that relates to the transaction.

Consequences of failure to disclose conflicts of interests

In the event of a director’s failure to comply with these obligations, or where a director is unable to prove that the transaction in question was reasonable and fair to the corporation at the time that it was approved, Business Corporations Acts give the corporation or a shareholder the right to bring a court application to challenge the transaction.

A person challenging such a contract or transaction in court can seek to set aside the transaction in question in which the director had conflicting interests and requiring the director to account to the corporation for any profit or gain realized from the transaction. A judge or arbitrator assessing the alleged wrongdoing will scrutinize the interests of all parties to the dispute, whether the director in question or the corporation took an unfair advantage of its powers, and to what extent any alleged undisclosed conflict of interests harmed the interests of the corporation.

Interested and qualified persons may also have recourse against the corporation or any of its affiliates through the oppression remedy. This is a broad statutory right based on the “reasonable expectations” of stakeholders. Our article, How to Handle Shareholder Disputes: Common Causes and Solutions also examines the oppression remedy along with other exit options.

Conclusion

Conflicts of interests of a director of a corporation in Canada can arise in a wide range of circumstances where the director’s financial or other personal interests can interfere with the best interests of the corporation. It can also arise where the director’s personal interests can interfere with his or her duty to act in the best interests of the corporation.

The director involved in this conflict of interests must be transparent and uphold his or her fiduciary duties to the corporation based on corporate governance rules and the relevant Business Corporations Act. This includes disclosing the conflict to the board of director, refraining from participating in discussions or voting on the transaction, and taking steps to make sure that the corporation’s interests are prioritized over their own personal interests.

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The information contained in this article is provided for informational purposes only and does not constitute legal advice. Readers should not act on this information without seeking professional legal advice from a lawyer experienced in this area. The content in this article may not reflect the most current legal developments, and the application of law can vary in different provinces and territories. As such, the information in this article is not guaranteed to be complete, correct, or up to date. The author and the publisher of this article disclaim all liability for any actions taken or not taken based on any or all of the contents of this site.

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