Fiduciary Duty owed by Managers & Directors

Fiduciary Duty owed by Managers & Directors When acting as a director, a director must: • Act honestly • In good faith • With a view to the best interests of the company o Means the director must place the company’s interests above his/her interests o Avoid conflicts of interest 3 different relevant fact patterns 1. Self-dealing: a director selling an asset to the company at too high a price (or buys something too low) 2. Corporate Opportunities: director learns about opportunity at a meeting, decides to pursue it individually 3. Competition: director has an interest in two competing businesses Self Dealing • Always involves a contract/transaction • Could be between director and corporation, or between some other entity he has an interest, and corporation • Potential for director to divert corporate wealth to himself, potential for divided loyalties (conflicts of interest) o As a shareholder, a director is motivated to generate wealth for the company; however, the increase in wealth from the transaction could be greater than the loss to the share value • Price difference between fair market value and sale/purchase price is incurred by the company (agency cost) Historically, rules against self-dealing were far stricter, now most commonwealth allow it, but heavily regulate it • legislation for self-dealing came before fiduciary duty provisions (so there are some discrepancies) • Provisions use the word ‘material’ in provisions, but don’t include definitions o For our purposes, material = ‘important and relevant’, when disclosure is required • The main point of self dealing is that the director must ‘account’ for his profits (ie. pay back $ to corporation) S 147 – (1) a director has a disclosable interest in a contract/transaction if: (a) the contract/transaction is material to the company; (b) company has entered or proposes to enter into the contract/transaction; and (c) either (i) director has material interest in contract/transaction, or (ii) director is a director/senior officer of or has a material interest in a person (company) that has material interest in the contract/transaction s 148 – director is liable to account to the company for any profit that accrues as a result of contract/transaction if director holds a disclosable interest s 149 – contract/transaction where disclosure has been made, in accordance with 148, can be approved by directors or by special resolution (more in legislation book) Corporate Opportunities • Completing governed by common law; highly fact dependent, and generally unresolved/unclear • Baron: probably not codified because disputes are generally settled outside court – no one wants codification • CL does not completely block the area of corporate opportunities; there are circumstances where it is okay Main issue in COs: did the director usurp the authority granted to him by the shareholder in order to acquire an “unbargained for” personal benefit? (this is another example of an agency problem) Regal (Hastings) v Gulliver [1942] (prior to statute – does not conflate duty of good faith / fiduciary duty like Laskin) F: Regal owned cinema in Hastings; company wanted to buy two more theaters as it was struggling • Regal formed a subsidiary company, and offered to lease 2 cinemas, but the landlord required guarantee of the rent by the directors unless the paid-up capital of the subsidiary was 5,000 pounds o Parent company was unable to provide more than 2,000 pounds o So, directors of company and solicitor put up 3,000 and the company put up 2,000 • The entire business, parent and subsidiary were sold to buyers; but, the directors who owned 3K shares made a profit of ~2 pounds per share – new directors of Regal are suing for breach of fiduciary duty as they gained profit A: company must satisfy two things: (i) that what the directors did could be said to have been done in the course of their management and in utilization of their opportunities and special knowledge as directors; and (ii) that what they did resulted in a profit to themselves • An agent must account for net profits acquired by him in the course of his agency, it does not depend on fraud or corruption o Even if they did not intend to make a profit, if they did make a profit, it is enough o Doesn’t matter if the company does not actually lose money • The rule is stringent and absolute because ‘the safety of mankind’ requires it to be absolutely observed in the fiduciary relationship C: 4 directors bound to pay back because they are directors who made a profit in course of positions (other facts are irrelevant) Peso Silver Mines v Cropper [1966] F: C was director of company that took over several silver mine claims, was instrumental in incorporating Peso • Company went public for financing the purchase of the claims, but later became financially strained • Peso was offered 3 groups of claims to more land– one was turned down by 6-man BoD because of financial constraints, and because it felt that Peso had enough land currently under control o Later, a few directors and a geologist for Peso created a company and took on the project as Cross Bow o Peso is fine with this at the time • Wrote letter to BC Brokers explaining transaction – main interest lies with Peso, but it was unable to buy, wanted to get land because other people are interested in acquiring it • Charter Oil bought Peso, demanded that Cross Bow turn over the interest in the claim I: Did Cropper breach his fiduciary duty? C: Finding for Cropper – can keep interest, does not have to pay back to Peso • even though he was a director and learned about it on the board, Peso declined the opportunity when raised o Baron: if C was negotiating on the side before Peso turned it down – would have been problematic A: impossible to say that C obtained the interests he held in Cross Bow and Mayo by reason of the fact that he was a director of Peso and in the course of the execution of that office • When C was offered the claim, it was his duty to take part in the decision of the board as to whether that offer should be accepted or rejected; at that point he stood in a fiduciary relationship with Peso o he and his co-directors acted in good faith, solely in the interests of Peso and with sound business reasons in rejecting the offer o the offer to C was not accompanied by any confidential information unavailable to any prospective purchaser, and he did not have access to any of this information by reason of his office • When the later proposal with respect to Dickson's claims was made to C, it was not in his capacity as a director of the appellant but as an individual member of the public Canadian Aero Services v O’Malley [1973] F: Main business of Canaero was topographical mapping and geographical exploration – Ds were assigned to map the country of Guyana • Ds then resigned from Canaero and incorporated Terra, to perform identical work; their proposal was competing with the proposal from Canaero • Canaero suing for breach of fiduciary duty 4 issues: (i) determination of relationship of defendants to company; (ii) duties, if any, owed by them to the company; (iii) whether there was a breach of this duty; (iv) if there was a breach, consider liability A: Does not matter whether the two people were properly appointed as directors of Canaero, they, in practice, acted as president and executive VP of Canaero for 2 years - Top management and not mere employees, • (Court considers them to be officer even though not technically on paper) • So then they have fiduciary relationship with company – betokens loyalty, good faith, avoidance of conflict of duty and self-interest – a director is precluded from obtaining for himself any property or business advantage either belonging to the company or for which it has been negotiating without approval from the company • • • • o Especially when the director has been participating in negotiations on behalf of the company None of the rigid rules in Regal should be applied rigidly; as in this and other new branches of the law, new fact situations may require a reformulation of existing principles o “particular facts may determine the shape of the principle of decision without setting fixed limits to it” Even though the project slightly changed, would be absurd to let them off on a technicality – they are close in enough that the projects can be considered the same thing Distinguished from Peso – Canaero maintained significant interest in the project; no good faith on behalf of D o Officers first negotiated parts of the deal as part of the company, then left and scooped it up Non-exhaustive list of factors to consider in each case: position held by D; nature of the CO - its ripeness specificness and the director’s relation to it, the amount of knowledge possessed, the circumstances in which it was obtained and whether it was special or private; timing with termination of relationship with other company, and the circumstances under which the relationship was terminated (retirement or firing) Competition In Law 459 the term competition refers to: • A Director serving on the boards of two competing corporations • A Director (or officer) operating a business that competes with the corp; or • A Director (or officer) having a material interest in an entity that competes with the corp o Each could involve a conflict of interest o Competition is competing against the corp, whereas self-dealing is making a deal with the corp Historically, judges looked at this as a conflict of interest in the sense of breach of fiduciary duty • Then, obscure motion from 1891 made its way into case in 1932 and changed the rules • London v Mashonaland [1891] – a person can be a director for both – nothing in articles that prohibits, no NCA o nothing prohibits him from acting as a director of this other company; no sufficient damage was shown • changed common law – allowed to sit on board of two competing companies, depending on facts and behavior – NCA or articles prohibiting competition would overrule this though • S 153 applies if nothing in articles, or no agreement (director must simply disclose other interest) o Director still must maintain fiduciary duty though Competition and corporate opportunities can have significant overlap – stealing the opportunity is essentially competing against the other corp – Slate shows interplay • distinction is fairly artificial, but we have s 153 for competition and common law for COs Slate Ventures v Hurley [1996] F: Hurley a director of Slate, purchased a slate quarry for himself without disclosing this to his company I: Was a breach of fiduciary duty? Current law on fiduciaries’ liability in Canada: • Where there is an actual conflict of interest and the information/opportunity is acquired by virtue of the fiduciary’s position, they are liable to account for any profit • Where there is a potential conflict of interest and info by virtue of position, they are accountable for any profit • Where there is a potential conflict, but information/opportunity was acquired independently, fiduciary is not accountable • Where there is an actual conflict, but information was acquired independently, fiduciary is accountable • Where there is no conflict, but the information was acquired by virtue of position, fiduciary is accountable A: Hurley did not acquire the information by virtue of his position as a fiduciary, but the quarry was important to the corporation because it would add slate reserves, provide different colours to meet consumer needs, and prevent competitors from entering market in NFLD • therefore because they had general interest in acquiring quarries and could purchase the properties • actual conflict of interest even though independently acquired knowledge – Hurley accountable – breach of FD Note: Slate [1997] – disagrees with finding that potential conflict of interest would not be enough Cranewood Financial Corp v Norisawa [2001] F: Competition scenario similar to Slate case – embraces appellate level decision A: Potential conflict of interest is enough, doesn’t have to be actual conflict of interest • Breach of fiduciary duty comes down to two questions: o (i) Was there either an actual or potential conflict of interest by virtue of fiduciary creating new company to pursue an opportunity?; OR o (ii) Were the opportunities acquired by virtue of their position with the companies as director/officer of the first company? § If either are satisfied, the fiduciary is liable to account Scholarly theories on the fiduciary duty • law and economics theory – purpose is shareholder wealth maximization; so directors must perform the function of generating effectively and efficiently (primary purpose) o if the director focuses on something other than that goal, they are breaching their fiduciary duty § Baron: very narrow and perhaps short-cited o duty to all stakeholders is not practical – lots of conflicts of interest, a duty to all will denigrate into a duty to none • Shareholder point of view – shareholders have a residual claim – if a corporation tries to maximize this claim (grow the value of shares) it will help most stakeholders (good for shareholders, creditors, etc.) o avoid taking risks, manage conservatively, etc. o this is at odds with the entrepreneurial spirit – taking risks, exploring new markets, innovation/failure o directors must balance this against conservative management • Shareholder primacy view o Shareholders choose to invest in corporations – in public corporations it is easy for them to exit o they are not protected by contract law like creditors and employees (no statutes other than BCA/CBCA) o shareholder primacy view – fiduciary duty should fill this gap by protecting the shareholders o simplistic though because duty is not actually owed to shareholders • Negotiating agency view – what would the perfect FD look like? A bargain – investors and agents are able to negotiate with each other at no cost o shareholder delegates authority to director (exchange liability for not having to make mgmt decisions) o FD rules preserve the gains resulting from the delegation of authority and the division of labour while limiting the ability of agents to further their own interests at the expense of investors (but duty to corp) the traditional common law concept reflected shareholder primacy rule, • but SCC rejects this rule in two decisions • corporation does not just mean the shareholders, or other stakeholders o they should only be focused on making the corporation a better corporation without regard to any particular group • “Thus in a short period of time, we have moved from one end of the normative spectrum to the other. It is up to you to decide which you prefer” • fair treatment – corporation and shareholders are entitled to maximize their share value, but cannot go so far to treat other stakeholders unfairly – what stakeholders are entitled to ‘reasonably expect’ (oppression remedy) To whom is FD owed? • Peoples – owed to corporation, not owed to each and every constituency like shareholders or creditors • Peoples and BCE treat the corporation as an abstract entity (eg. what is best for the bus analogy) o A decision could be good for the corporation but not ideal for any specific group of stakeholders • People’s – not mandatory to consider various constituencies, but then: o BCE: directors have a duty to consider the best interests of the debenture holders • What can directors do to discharge their fiduciary duties? o Form committees o Get advice from outside experts o Engage in consultation o Use BJR to decide how much $ to spend on those reports vs benefits of those reports • Many times, consultations are just a box to check, they file it in minute book and do what they want anyways • BJR can be used with FD or duty of care, or both – directors can rely on it o If directors follow procedure found in BCA, directors will tend to avoid liability • part of the reason for duty to corporation is because there are actually major divergences between different groups of shareholders and their interests Old Conflict and Profit Rules • The Conflict Rule – any conflict of interest was not tolerated o Directors could not sit on two boards o Eg. Blaikie is a partner a firm that sells railway chairs to a corp, of which he is a Director § As a Director he has an interest in getting the lowest price (for the buyer) but as a Partner, he has an interest in getting the highest price (for the seller) § This is a conflict of interest: divided loyalties § HL decides the transaction is voidable at the option of the corp • The Profit Rule – a fiduciary cannot earn a profit from his office o Historically, where there is a conflict, it usually follows that the Director will make a profit from it o Conflict and Profit went hand in hand o The conflict and profit rules were strictly enforced (Regal) • Now this has changed though, old rule is far to strict o courts apply different standards in different situations – no strict rules o Canaero - Laskin J. seems to create a different duty for corporate opportunity cases o SCC found that the 2 people appropriated a CO and ordered them to hand over the profit they made o Laskin J. took the old C&P rules and mixed them with the modern “good faith” standard (FD) § You could say then, that we still have these rules to some degree • Judges will still use old common law if it fits with the legislation, that has room for interpretation – if old common law conflicts though, legislation will be the rule Self-dealing/Competition Shareholder Protection • There are exceptions to self-dealing and competition that involve disclosure to and approval by the Board, and shareholders may view these documents in the minute book • An interested, diligent shareholder may view minute book, see lots of self dealing and then choose to vote for a different director (protection here, unless shareholder is very passive / does not care) Hostile Takeover Bids – offer made by person or corporation (acquirer – specific entity does not matter) to shareholders to purchase all of the shares of the target corporation • acquirer is seeking to buy enough shares that they can take control of the target • why hostile? Done without approval of directors of the target – they will probably lose jobs by being voted out • being human beings who want jobs (self interest) – they do what they can to block this from happening o sometimes will issue shares, sell to themselves or people who are friendly to them o under the old law, if acquirer challenged this, the court would side with them (improper purpose rule) • Now, if a corporation genuinely needed to raise money, that was a bona fide reason and the issuance of shares could stand (if you can show that you needed to build a factory, you’re probably okay) • other times, the bid would actually be in the best interest of the company – director has divided loyalties / CoI Teck Corp v Millar [1972] F: junior mining company needs help getting to the next step – need major investment or ‘ultimate deal’ • an issuance of a controlling block of shares to the major company sufficient to allow for full development of the junior’s mining properties – Afton needed this investment o Two different companies wanted ultimate deal with Afton – Teck and Canex • Director of Afton (Millar) felt Canex would do a better job, and they needed operating funds o sold non-controlling block to Canex because they needed cash but were not ready for ultimate deal • Teck sees this and starts buying Afton’s shares in market; M knows they are getting closer to acquiring control • Millar proposes 70% Afton, 30% Placer (subsidiary of Canex) • Teck is worried that Millar will make ultimate deal with someone else, calls a meeting of shareholders of Afton o Says do not sign this deal without consulting us – hear us out on our deal o Teck then bought enough shares that they control the board • Afton’s lawyer says ignore it, no meeting yet, so just sign the deal you want to do • Millar signs deal, and then Teck sues them for breach of fiduciary duty A: Old common law says a director cannot block a hostile takeover • But court asks why issuing shares to block a bid is segregated from other steps directors can take if they believe it is in the best interests of the corporation – court inquiries into the reason for the blocking • General rule: directors must act in good faith – there must be reasonable grounds (objective for their belief; if they say the company’s interests will be substantially damaged, there must be reasonable grounds for that belief; if not, justifies a finding of improper purpose • Directors should be entitled to use their powers to protect the company, if it is in the company’s interests • Defendants were elected to exercise their best judgement – they were not agents bound to accede to the directions of the majority of the shareholders, their mandate continued as long as they were in office • They acted in what they conceived to be the best interests of the shareholders, and signed a contract which they knew the majority shareholder did not want them to sign – they had a right in law to do that Note: In Canada, in change of control situation, if the board wants to get protection under BJR, they should set up committee; the courts want to see that the director made a decision that was reasonable – court will not substitute its own opinion if its reasonable at the time (even if since it has gone very wrong) Pente Investment Management v Schneider [1998] F: Schneider corp was 108 year old family business, went public in the 1960s • Company had different classes of shares – when it went public, family kept full control of one class • In the 1980s, family altered the articles to allow for a coat-tail provision o In a takeover bid, we assume acquirer is getting voting shares – coat-tail provision says that if a takeover bid happens, the family have right to convert their class A shares into voting shares o This is in effect diluting the shares such that acquirer must buy more; can veto a takeover bid • Maple Leaf wants to take over the company without negotiating with Schneider’s board – triggers coat-tail • Board then establishes special committee of the board, independent from the family o Committee looks at offer in great detail, and consider other alternatives • Family tells committee that they will consider Smithfield’s deal (better company values, decent offer 25/share) o Maple Leaf responds with 29/share offer o Smithfield’s deal would save the family tax money – offers after tax were basically equal same • Five class A shareholders felt that the committee was taking way too long – “the actions or inaction of the Committee, together with those of the Schneider family have in effect, contaminated the value maximization process outlined by BoD in its circular and public statements” I: did the directors act in the best interest of the corporation? A: If there are no reasonable grounds to support an assertion by the directors that they acted in the best interests of the company, a court will be justified in finding that the directors acted for an improper purpose (Teck) • How do we learn if they acted in the best interests of the company? • One way is “to ask what was uppermost in the directors’ minds after a reasonable analysis of the situation” o Acting in the best interests of the corporation does not mean that the directors must choose one of the stakeholder groups and act in that group’s best interest o However, if the directors have unfairly disregarded the rights of a group of shareholders, then the directors will not have acted reasonably in the best interest of the corp, and the court will intervene • The fact that alternative transactions were rejected is irrelevant unless it can be shown that a particular alternative was definitely available and clearly more beneficial to the corp than the chosen transaction • The real question is whether the directors of the target successfully took steps to avoid a conflict of interest o Here, they created an independent committee – Should they have done that? Yes o Was the committee independent from the board and the family? Yes o Did the members of the committee act in good faith in the sense that they acted honestly? Yes o Were the members of the committee well-informed? Yes • reason to appoint special committee is to make sure that no stakeholders are unfairly disregarded or prejudiced • To ensure the best interests of the corporation are met, it is appropriate to explore alternatives to unsolicited (not asked for) takeover bids – this does not mean the family was obligated to accept a bid C: both the board and the committee fulfilled their duties – so request by 10% of shareholders was not successful Sanction of breach of FD by shareholders • Old common law: Foss v. Harbottle [1843] o if the majority votes to ratify a breach, the minority has no standing to complain (the majority votes on basically anything, minority is out of luck) • if the company suffers harm, the company is the only the claimant, not the minority shareholders North-West Transportation Company v Beatty [1887] (follows Foss) F: Director sold his steamship to his company, which was approved by ratification at meeting because he was also a significant shareholder of the company • Price was reasonable, and boat was actually used in course of business – not a frivolous purchase • Minority shareholder arguing that this director’s fiduciary position was so strong that he should not have under any circumstance entered into this contract A: the majority of votes must prevail, unless the adoption was brought about by unfair or improper means (or fraudulent or oppressive to minority) – only unfairness here is that Beatty had so many shares to vote on this • The constitution of the company enabled the director to acquire his voting power, no limits in articles o So articles do not change the default common law here o Just because someone is a director, does not mean that they cannot vote as a shareholder • Summary of 4 levels of court: • Chancery = set aside the sale; James was in a conflict between duty and interest (director, shareholder and vendor all at the same time) • CoA = reverses; the resolution to purchase the steamer was a pure question of internal management, and shareholders had a perfect right, either to ratify it [or, treat the matter as an original offer to themselves, and to agree to it and complete the purchase] • SCC = affirms the Chancellor; this case turns entirely on FD character of James as director: he should have been impartial and neutral (We can read into this that he should have abstained from voting as shareholder] • PC = one one hand, they do not want to relax the rules against self-dealing, but, on the other hand, voting is voting, and just because someone is a director does not mean he can’t vote as a shareholder, if he is also a shareholder (affirms CoA – it is okay) Baron: court was too deferential to majority – now law is different Dickerson report suggested that the minority shareholders should be protected more • Current Law – BCA s 142(3) no provision in a contract, memorandum or articles relieves a director from the duty to act, or from liability (eg. breach of any duty) • Some breaches of duty by Directors may be ratified by a shareholders resolution • Some breaches cannot be ratified (e.g. unlawful dividends, fraud on minority shareholders) • Procedures are spread out throughout the BCA • S 157 directors are relieved of liability under s 142(1) if they relied in good faith on documents listed in s 157(1)