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Roles of Shareholders and Directors

A. Source

The following material is excerpted from a guide on Directors' Responsibilities and Liabilities by Osler Hoskin & Harcourt LLP.

B. Separating the Shareholder Roles and Director Roles

With Angels and venture capital investors assuming active participation in company management, there is often some confusion about the respective roles of directors, shareholders, and management.

  • The role of directors is one of stewardship. Directors are responsible for managing or, under some statutes, supervising the management of, the corporation. If the Board of Directors is dissatisfied with company management, its recourse is through the company's CEO. If the CEO is not performing as expected, the Board may replace him.1

  • Shareholders make a financial investment in the corporation, which entitles those with voting shares to elect the directors. Shareholders do not normally have any rights to be involved directly in company management. Their connection to company management is typically via the Board of Directors as described above. 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.

C. 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 common law and various statutes seek to establish the parameters of this duty without limiting the flexibility of these principles.

1. 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 “shareholders as a whole.” However, in reaching their decisions, directors are often confronted with a number of competing interests. In recent years, some courts have been prepared to give directors more scope in considering the interests of different persons affected by corporate acts without encroaching on the principle of acting in the corporation's best interests.

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 “stakeholders” such as employees, creditors, and the community or country in which the corporation carries on business who may be affected by the actions of the corporation. Considering these interests is often in the long-term best interests of the corporation. Nevertheless, no court has ever recognized a duty to such stakeholders.

2. Directors Duty to the Interests of the Shareholders
Courts have held that directors owe a duty to the corporation and not its individual shareholders. In many 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 may be instances where the interests of the corporation and its particular shareholders or classes of shareholders diverge. The interests of the common shareholders may lie 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.

Additionally, the interests of majority shareholders may not be the same as the interests of the corporation. A controlling shareholder may want the corporation to take certain action that may be in its interest, but not necessarily in the best interests of the corporation. The right solution to these kinds of issues depends very much on the facts of each situation.

3. Directors Duty to the 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. Debenture holders 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.

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. Such legislation was enacted in the wake of high levels of take-over activity in the 1980s (particularly by non-Americans) and was, at least in part, a response to decisions facing boards of directors that had significant implications for stakeholders of the corporation other than shareholders. These state statutes have been the subject of extensive criticism and in some states have been repealed.

D. Directors' Conflict of Interest

Directors may have a number of relationships that will put them in a position of conflict or give rise to an obligation to disclose details of a relationship.

1. When Does a Conflict Arise?
Directors who have an interest in a contract or proposed contract (e.g. a term sheet) with the corporation must consider the matter carefully. 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.

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 that 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 voting as directors, however, they must still act in 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 with reference to the materiality threshold of the corporation.

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 timeframe prescribed by the relevant corporate statute.

2. Voting and Abstaining from Voting
Directors cannot normally vote on a contract in which they have a material interest. There are exceptions for contracts that involve the directors' remuneration or an indemnity in which 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 that 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, and 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.

E. Reviewing the Role of Shareholders

1. General
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 series of 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.

2. 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.

1Note: Especially in private companies involving venture capital investment, it is not uncommon for certain decisions that are normally made by the Board of Directors to require venture capital investor approval. A common example are key management decisions and financing decisions.

 


 
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