Rajah Lehal

As A Sole Director Of A Corporation, Should I Be Concerned About Making Decisions That I May Personally Benefit From?

August 14, 2020

For the sole director of a corporation, when making decisions, one potential concern is the requirement (that flows from their fiduciary duty pursuant to s.134 of the Ontario Business Corporations Act (R.S.O. 1990, c. B. 16) “OBCA”) to avoid a conflict of interest with the corporation.

Majority shareholders who are also executives in a company, and sole directors will often have to make decisions where they have a personal interest in the outcome. For majority shareholders, they may have the opportunity to review arrangements with a personal benefit with a board of directors — and for corporations with many directors, a potential solution could be the conflicted director recusing themselves from the decision. However, what do you do if you’re the only director at the company? In situations where there are no other directors who could make the decision instead, this represents a challenge.

Potential Problem:

If a sole director needs to make a decision regarding their own employment contract, is there a conflict of interest?

Can An Executive “Slip” a Tough Decision Through?

If there is an active board, that’s tough to do, and not recommended. The company may sue to have the contract unwound and the funds returned.

For example, in Waddilove v 1748960 Ontario Limited (2018) (Waddilove), the Ontario Superior Court considered a similar situation where an officer of a corporation (subject to the same fiduciary duties as a director) (Paragraph 39) drafted his own employment contract which was executed by his family and friends (Paragraph 51). The issue was that the officer’s contract contained material differences from the other employment contracts that effectively gave the officer financial stability regardless of job performance (Paragraph 46).

These differences were not disclosed to the board of directors. The court held that the contract is unenforceable as the officer should have disclosed the contract and his position of conflict to the board (Paragraph 65).

Can a Board Seek Legal Advice in Order to Make Tough Decisions?

A board might seek legal counsel to determine whether a benefit to one shareholder/board member/executive is legally possible. Ultimately the decisions on whether to disproportionately benefit one person to the expense of the others is a board decision, and the board needs to act in the best interest of the corporation. (For more details on this, search our articles on board liability, fiduciary duty, business and judgement).

Consider this article provided by our partner Mondaq.com, that analyzes another case decision (Look Communications Inc. v. Cytrynbaum) made by the Ontario Superior Court.

In that matter, the board of directors approved large payments to the company’s directors, officers, and employees not commensurate with the company’s financial position. The court held that the payment was excessive and not in the best interests of the corporation. In addition, the details of the payment were not disclosed to the shareholders until after the transaction. Accordingly, the court ordered the directors to pay restitution to the corporation. The court also held that — as this is a business matter, the board could not absolve themselves of liability by claiming that they relied on legal advice.

Legal Framework:

In Can. Aero v. O’Malley (1973), the Supreme Court of Canada discussed the general duties of a director or a senior officer of a corporation:

  1. Loyalty;
  2. Good faith; and
  3. Avoidance of a conflict of interest and self-interest.

On page 621 of the case, the court held that the duties are contingent on the specific fact scenario; therefore, did not set out any bright-line tests.

Still, the court went on to enumerate some factors to help judges adjudicate a potential breach of these duties.

The most relevant factors for this article are listed in Page 621 of the case [additional language added to assist us in thinking about this topic]:

  1. Position or office held;
  2. The nature of the corporate opportunity; its “ripeness”, specificness and the director’s or managerial officer’s relation to it [in other words, “What’s the conflict?” How “big” is the conflict? How financially impactful is the conflict?];
  3. The amount of knowledge possessed [in other words who knew about this conflict?];
  4. The circumstances in which “it” was obtained and whether it was special or, indeed, even private;
  5. The factor of time in the continuation of fiduciary duty where the alleged breach occurs; and
  6. [If the conflict or management relationship ended:] the circumstances under which the relationship was terminated, that is whether by retirement or resignation or discharge.

Potential Solutions?

Recruit a Bigger Board

The most certain way for a sole director to avoid the possibility of conflict — would be to recruit additional decision-making board members. This would allow the conflicted director to recuse themselves from voting on the relevant matter.

If the above is not possible or practical, in BCE Inc. v. 1976 Debentureholders (2008), the Supreme Court of Canada discussed possible avenues for redress in situations where a conflict of interest occurs. The court held that the directors need to “resolve them in accordance with their fiduciary duty to act in the best interests of the corporation, viewed as a good corporate citizen” (at paragraph 81 of that case). The court also held that there are no absolute rules and directors have to treat individual stakeholders affected by their actions equitably and fairly (at paragraph 82 of that case).

Recruit Independent Ddvisors (Board of Advisor, Ombudspersons)

For sole directors, one possible solution to avoid an inadvertent breach of their fiduciary duties would be to recruit a board of advisors, or ombudspersons who could advise independently in situations (without specific decision making abilities) where a potential conflict of interest arises. This could help provide evidence that shows that the sole director is not shirking their fiduciary duties. However, keep in mind that, just in the example above in which, relying on a discussion or advice from legal counsel did not absolve the board of directors from liability, in this case, the independent board of advisors may also fail to act as a shield from liability.

Disclose the Conflict to Shareholders and Ask For Approval

In an article posted on our partner site Mondaq.com on the Waddilove case (also discussed above), the author proposes a potential solution. The officer in question, if he acted honestly and in good faith, pursuant to s. 132(8) of the OBCA, could have disclosed the conflict to the shareholders and had them ratify it.

This approach was also supported in Reeves v. Russell (2009), the court considered the enforceability of a commercial lease agreement. One of the issues was a potential conflict of interest; the defendant was a shareholder and a director of the lessor and the sole director and shareholder of the lessee (Paragraph 84). The Ontario Superior Court held that the defendant had disclosed his personal interest to all of the other pertinent parties (Paragraph 87). Due to this disclosure, the lease agreement was not set aside.

Takeaways:

  1. Best solution: The best way for a sole director to avoid a conflict of interest is to completely avoid the situation by recruiting additional decision-making board members.
  2. Good solution: The sole director should disclose his conflict of interest (preferably in writing) to all of the relevant stakeholders (for example: the shareholders of the corporation).
  3. Possible solution: Recruit a board of advisors, or ombudspersons who can advise in situations where the sole director has a conflict of interest - this presents a weak shield as compared to the other two solutions.
Employment Agreement
Board of Directors

Written by Rajah. Rajah Lehal is Founder and CEO of Clausehound.com. Rajah is a legal technologist and technology lawyer who is, together with the Clausehound team, capturing and sharing lawyer expertise, building deal negotiation libraries, teaching negotiation in classrooms, and automating negotiation with software.