Rajah Lehal

Why Indemnify? Director’s Liability – Sources and Mitigation

October 17, 2017

When most of us think about directors of corporations, what comes to mind is the hefty pay (at least in bigger corporations), the prestige, and the power. But with power comes responsibility; the subject of our discussion. This article briefly outlines the sources of liability for directors, and the means by which to mitigate those liabilities: indemnification clauses.

Directors have two basic duties to the corporation.

The first is a fiduciary duty or a duty to act honestly and in good faith in the best interests of the corporation [CBCA, s.122(1)(a); OBCA s.134(1)(a)]. A director’s fiduciary duty might come into question if they are personally transacting with the corporation, taking corporate opportunities for themselves (seeCanadian Air Services Ltd. v. O’Malley for an example of what this might look like), or competing with the corporation while having a fiduciary duty to the corporation.

The second is a duty of care which is fulfilled by exercising the level of care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances [CBCA, s.122(1)(b);OBCA s.134(1)(b)]. At the very least, directors ought to have a basic level of competence to perform the job. If they do not, they should acquire the necessary skills or resign before incurring liability for breaching this duty. The duty becomes more stringent when the director possesses a particular skill or qualification. For example, a director who is a qualified accountant would definitely be in breach of their duty of care if they did nothing to address a failure to withhold income tax from employee wages.

The directors are also subject to statutory liability under various federal and provincial statutes for failure of the corporation to comply with the statutory obligations (eg. environmental regulations, employee wages). The Library of Parliament has published a discussion of these points here and, in it, comments on the tension between directors’ responsibilities for maximization of profits and good corporate citizenship.

Furthermore, when a shareholder or group of shareholders feel the corporation has acted in a manner that harms the corporation, they can seek what is called derivative action against the directors. If they feel their own interests have been unfairly disregarded or prejudiced, they may pursue an oppression remedy.

All of these sources of liability create accountability to the corporation but can scare off qualified individuals from taking on the role of director. No director will willingly want to bear the out of pocket legal expenses associated with such disputes. The potential director will likely want some measure of assurance in the form of an indemnification clause such as the sample below:

3.3 The Corporation will defend, indemnify and hold harmless the Executive from and against any liability and expenses arising by reason of the Executive acting as a director or officer of the Corporation or any subsidiary or affiliate thereof. The Corporation will obtain liability insurance (“D&O Insurance”) for the benefit of the Executive.

(From https://clausehound.com/legal-contract/16296)

However, an indemnification clause is only as good as the ability of the indemnifier to pay it. Often it is accompanied with language requiring the director, the corporation, or both parties to undertake a Director and Officer (D&O) Insurance policy. The policy should clearly state what rights and obligations the director has and what protections are extended to the director by the organization. For more considerations regarding indemnification provisions, seethis article on our partner site, Mondaq.

For more on insurance, check out these links:

Take-away: When drafting indemnification provisions, balance the interests of the corporation against the interests of the director. Consider:

  • What concerns might an individual have before taking on the responsibilities of a director?
  • What concerns might a corporation have about a director’s behaviour?
  • By what means will the indemnity be provided?

For more information, check out these blog posts:

*Author: Sahil Kanaya*

Company Formation
Articles of Incorporation
Canada (ON)
Canada (General)

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.