Director liabilities for Canadian startups
If you act as a director of a startup, you are exposed to potential personal liability. The application of personal liability is intended to ensure that directors are accountable to the corporation they serve, and are responsible for the failure of the corporation to meet certain of its legal obligations.
(i) General duties under common law and corporate statutes
The common law and corporate statutes each impose several duties on directors that may result in personal liability.
- Fiduciary duty. Directors are considered fiduciaries of the corporation. This principle requires directors to act honestly and in good faith with a view to the best interests of the corporation, to put the corporation’s interests ahead of their own, and to avoid conflicts of interest. Conflicts typically arise where a director holds a personal interest in a material contract with the corporation or gains an opportunity because of information obtained in his position as a director. Directors are required to disclose all such conflicts and refrain from voting on any related resolution. Failure to disclose a conflict may make a director liable for any gain earned from the conflicting interest. Directors are also generally prohibited from taking advantage of a business opportunity that the corporation either had or was seeking. Taking advantage of such corporate opportunity may attract personal liability even where a director resigns prior to engaging in the opportunity, and the corporation suffers no demonstrable loss from the breach of fiduciary duty.
- Minimum standard of care. Directors are required to provide a minimum standard of care in carrying out their responsibilities. This minimum standard is generally described in the corporate statutes as exercising ‘the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances’. Courts generally apply the business judgment rule in evaluating whether the minimum standard has been applied, which is a focus on the procedure applied in coming to a decision, rather than the results of such a decision. Inside directors and individuals who hold other positions within management may also be held to a higher standard of care than outside or independent directors, since they are generally better informed about the corporation’s affairs.
- Delegation and reliance. While directors may delegate authority and responsibility to management, independent advisors and special committees, all work is performed under the general supervision of the directors. Directors are entitled to rely on the information provided by officers and other employees, provided that the directors have verified that the source is qualified and makes the proper inquiries when the work product is presented to them. Directors should keep in mind that they are liable for any acts or omissions of the board of directors carried out in their absence, since they are deemed to have consented unless they register their dissent according to the procedures set out in the governing corporate statute.
(ii) Specific statutory liabilities
Various provincial and federal statutes impose personal liability on directors. Some of these liabilities may arise even without the wrongful or negligent conduct of the director. For directors of early stage technology companies, some of the most commonly encountered statutory liabilities include the following:
- Actions in contravention of the business corporations statutes. Under both the federal and Ontario business corporations statutes, directors who vote for or consent to a resolution authorizing any of the following actions are jointly and severally liable to restore to the corporation any amounts distributed or paid (that are not otherwise recoverable by the corporation) as a result of:
o Purchase, redemption or other acquisition of shares contrary to the relevant legislation;
o A payment of commission contrary to the relevant legislation;
o A payment of a dividend contrary to the relevant legislation;
o A payment of an indemnity contrary to the relevant legislation;
o A payment to a shareholder contrary to the relevant legislation; and
o The issuance of shares for inadequate consideration.
- Employee-related liabilities. Directors are personally liable to employees of the corporation for up to six months of unpaid wages payable for services rendered while the directors served the corporation. In Ontario, directors are also personally liable for up to twelve months of vacation pay that accrued while they were acting as directors to the corporation. Directors can also be held liable for a corporation’s failure to remit source deductions such as Canada Pension Plan and Employment Insurance on behalf of its employees, and for a corporation’s failure to comply with provincial occupational health and safety legislation requirements.
- Tax legislation. Personal liability arises for directors as a result of a variety of offences under federal and provincial tax statues, including a corporation’s failure to remit any prescribed amounts under the federal Income Tax Act and Excise Tax Act (covering the Goods and Services Tax).
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