Recent Supreme Court Judgment on Directors'
Liability
By: Catherine Francis, Litigation and
Insolvency Partner, Minden Gross
On Friday,
October 29, 2004, the Supreme Court of Canada
released its decision on the appeal in Peoples
Department Stores Inc. (Trustee of) v. Wise.
This long-awaited decision was widely hoped to
clarify the duties of corporate directors to
creditors.
By way of background, the trustee
in bankruptcy of Peoples sued the Wise brothers,
former directors of Peoples, for breach of
fiduciary duty. In 1998, Mr. Justice Greenberg
of the Quebec Superior Court granted judgment in
favour of the trustee, holding that directors
owe a fiduciary duty to creditors when a
corporation is in the vicinity of insolvency. In
February 2003, the Quebec Court of Appeal
reversed, holding that the directors' duties
were owed only to the corporation, representing
the interests of shareholders, and that the
directors did not breach any duties.
The Supreme Court of Canada has now dismissed
the trustee's appeal. In doing so, however, the
court has delivered on its much hoped-for
clarification of the duties of directors toward
creditors, and has bestowed potentially broader
rights to creditors than have ever previously
been recognized anywhere, within or outside
Canada. Most importantly, the court did not tie
these rights to a finding that the corporation
is operating in the vicinity of insolvency. The
court has found that directors always owe a duty
of care toward creditors.
The following are a
few key findings:
"At all times,
directors and officers owe their fiduciary
obligation to the corporation.
"The interests of the
corporation are not to be confused with the
interests of the creditors or those of any other
stakeholders".
"We accept as an
accurate statement of law that in determining
whether they are acting with a view to the best
interests of the corporation it may be
legitimate, given all the circumstances of a
given case, for the board of directors to
consider, inter alia, the interests of
shareholders, employees, suppliers, creditors,
consumers, governments and the environment".
"The interests of
shareholders, those of the creditors and those
of the corporation may and will be consistent
with each other if the corporation is profitable
and well capitalized and has strong prospects.
However, this can change if the corporation
starts to struggle financially. The residual
rights of the shareholders will generally become
worthless if a corporation is declared bankrupt.
Upon bankruptcy, the directors of the
corporation transfer control to a trustee, who
administers the corporation's assets for the
benefit of creditors. ...
In using their skills for the benefit of the
corporation when it is in troubled waters
financially, the directors must be careful to
attempt to act in its best interests by
creating a "better" corporation, and not to
favour the interests of any one group of
stakeholders. ...
In
assessing the actions of directors it is
evident that any honest and good faith attempt
to redress the corporation's financial
problems will, if successful, both retain
value for shareholders and improve the
position of creditors. If unsuccessful, it
will not qualify as a breach of the statutory
fiduciary duty".
-
Hence, although the
court did not recognize a fiduciary duty to
creditors, it also did not recognize a fiduciary
duty to shareholders per se, but only a duty
owed to the corporation itself;
-
The court went on to
discuss the availability of the "oppression
remedy" under the CBCA. This remedy permits a
"complainant" (which includes a security holder,
director, officer and any other person who, in
the discretion of a court, is a proper person to
make an application) to seek relief from the
courts on the basis that the corporation or its
affiliates have engaged in oppressive or
unfairly prejudicial conduct, stating:
"The oppression
remedy of s. 241(2)(c) of the CBCA and the
similar provisions of provincial legislation
regarding corporations grant the broadest rights
to creditors of any common law jurisdiction ...
Section 241 of the CBCA provides a possible
mechanism for creditors to protect their
interests from the prejudicial conduct of
directors. In our view, the availability of
such a broad oppression remedy undermines any
perceived need to extend the fiduciary duty
imposed on directors by s. 122(1)(a) of the
CBCA to include creditors. ...
In light of the availability both of the
oppression remedy and of an action based on
the duty of care, which will be discussed
below, stakeholders have viable remedies at
their disposal. There is no need to read the
interests of creditors into the duty set out
in s. 122(1)(a) of the CBCA".
-
After having found
that the fiduciary duty is owed only to the
corporation (taking into consideration all
stakeholders) and having affirmed the direct
rights of creditors under the oppression remedy,
the court went on to find that directors also
owe a direct duty of care to creditors under s.
122(1)(b) of the CBCA:
"… unlike the
statement of the fiduciary duty in s. 122(1)(a)
of the CBCA, which specifies that directors and
officers must act with a view to the best
interests of the corporation, the statement of
the duty of care in s. 122(1)(b) of the CBCA
does not specifically refer to an identifiable
party as the beneficiary of the duty. Instead,
it provides that "[e]very director and officer
of a corporation in exercising his powers and
discharging his duties shall . . . exercise the
care, diligence and skill that a reasonably
prudent person would exercise in comparable
circumstances." Thus, the identity of the
beneficiary of the duty of care is much more
open-ended, and it appears obvious that it must
include creditors".
-
It is noteworthy that
the Supreme Court did not restrict the duty of
care to creditors when the corporation is in the
vicinity of insolvency - but that the duty is
owed at all times.
-
In discussing this
issue, the court embraced a high standard of
care for directors, while at the same time
explicitly recognizing what is known as the
"business judgment rule":
"Directors and
officers will not be held to be in breach of the
duty of care under s. 122(1)(b) of the CBCA if
they act prudently and on a reasonably informed
basis. The decisions they make must be
reasonable business decisions in light of all
the circumstances about which the directors or
officers knew or ought to have known".
-
One of the issues in
the Peoples ccase was whether the Wise brothers
could be found liable for inter-corporate
financial assistance. The Quebec Court of Appeal
held that this could not be improper because
such financial assistance was permitted under
then s. 44 of the CBCA. The Supreme Court of
Canada overturned this part of the Quebec Court
of Appeal's ruling, stated:
"The Court of Appeal
erred in concluding that s. 44(2) served as a
blanket legitimization of financial assistance
given by wholly-owned subsidiaries to parent
corporations. In our opinion, it is incumbent
upon directors and officers to exercise their
powers in conformity with the duties of s.
122(1). ...
Although s. 44(2) authorized
certain forms of financial assistance between
corporations, this cannot exempt directors and
officers from potential liability under s.
122(1) for any financial assistance given by
subsidiaries to the parent corporation".
- The Supreme Court of Canada has also
provided a useful analysis of the "reviewable
transaction" provisions of the Bankruptcy and
Insolvency Act, disagreeing in part with the
Quebec Court of Appeal's legal analysis, but
concurring in the result reached in this
particular case.
In summary, the decision of the Supreme Court
of Canada in Peoples gives explicit recognition
to the rights of creditors as stakeholders of a
corporation, while at the same time providing
directors with wide latitute for honest, good
faith informed business judgments. Ultimately,
the Wise brothers prevailed on appeal because
both the Quebec Court of Appeal and the Supreme
Court of Canada held, on the facts of this case,
that they had acted honestly, in good faith,
without negligence, and that their actions did
not cause the corporation's bankruptcy.
© 2004 Minden Gross Grafstein & Greenstein
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