A welcome clarification of the duties owed by Canadian directors, the top
court's decision in Peoples v. Wise also highlights the
importance of transparency, diligence, prudence and process in reaching
reasonable business decisions.
In a unanimous decision, the Supreme Court of Canada held in Peoples
v. Wise that directors of Canadian corporations owe a fiduciary duty to
the corporation and, in particular, do not owe fiduciary duties to creditors of
the corporation. The Court also confirmed that the standard of care for the
discharge of directors' duty of care is an objective standard and that under the
Civil Code of Québec creditors may bring an action against directors for breach
of duty of care. In addition, the Supreme Court recognized the existence of a
Canadian "business judgment rule." The Court's decision focussed on the duties
of directors of a corporation that was verging on insolvency. However, it will
have broad implications on the scope of directors' duties under corporate law
generally and on the manner in which directors should fulfill their duties.
In 1992, Wise Stores Inc. bought Peoples Department Stores Inc. Three
brothers of the Wise family were majority shareholders, officers and directors
of Wise Stores, and became the only directors of Peoples.
Peoples was not a profitable operation at the time it was purchased and its
business continued to deteriorate. The Wise business also ran into financial
difficulty. On the recommendation of the vice-president of administration and
finance of both Wise Stores and Peoples, the Wise brothers agreed to implement a
joint inventory procurement policy, under which the two companies would divide
responsibility for purchasing inventory. Peoples would make all purchases from
North American suppliers and Wise Stores would, in turn, make all purchases from
overseas suppliers. Peoples would then transfer to Wise what it had purchased
for Wise, charging Wise accordingly, and vice versa. Within a year of adopting
the new policy, both Wise and Peoples declared bankruptcy, leaving Peoples with
an uncollectible receivable from Wise Stores.
Peoples' trustee in bankruptcy sued the Wise brothers. The trustee claimed
that, in implementing the joint inventory procurement policy, the Wise brothers
had favoured the interests of Wise Stores over Peoples in breach of their duties
as directors under Section 122(1) of the Canada Business Corporations
Act (CBCA) - duties that the trustee alleged were owed directly to Peoples'
creditors. The trial judge found the Wise brothers liable on both grounds, but
the Québec Court of Appeal set aside the trial judge's decision.
Duties of Directors
The Supreme Court confirmed that the duties of directors under Section
122(1)(a) and (b) of the CBCA are distinct.
Fiduciary Duty of Directors
Directors' fiduciary duties are set out
in Section 122(1)(a) and require that directors "act honestly and in good faith
with a view to the best interests of the corporation." The Court confirmed that
directors owe their fiduciary duty solely to the corporation, and not to any
particular stakeholder group. The Court also confirmed that directors may take
into consideration the interests of the corporation's various stakeholders,
provided that they do not disregard entirely the interests of a particular
stakeholder group. However, at all times, directors owe their fiduciary
obligations to the corporation, and the corporation interests are not to be
confused with the interests of the creditors, the shareholders or those of any
The Supreme Court affirmed that an honest and good faith attempt to redress a
corporation's financial problems does not, if unsuccessful, qualify as a breach
of fiduciary duty where there is no evidence of fraud, dishonesty, personal
interest or improper purpose.
The directors' fiduciary duty to the corporation under the CBCA contrasts
with the statutory duty of directors in the U.S. to the corporation's
shareholders as a whole. In a departure from lower court decisions in Canada and
by courts in other commonwealth jurisdictions and the U.S., the Supreme Court
also held that a director's fiduciary duty does not shift to creditors when a
corporation is in the nebulous "vicinity of insolvency."
Standard of Care Is Objective
The statutory standard of care that
directors are required to meet in discharging their duties under Section
122(1)(b) of the CBCA is an objective one. The Court appears to have put paid to
the suggestion that the individual skills and expertise of directors will affect
the standard of care expected of them. Directors identified as having audit
committee financial expertise, for example, may take comfort that, in
discharging their responsibilities as directors, they will not be held to a
higher standard than that of a reasonably prudent person in comparable
Business Judgment Rule Affirmed
In its decision, the Supreme Court
affirmed the existence of a Canadian "business judgment rule," whereby the Court
will defer to the business judgment of the directors provided that an
appropriate degree of prudence and diligence was brought to bear in reaching a
reasonable business decision at the time it was made. The Supreme Court
re-iterated that perfection is not demanded.
Ultimately, the Supreme Court agreed that the Wise brothers did not breach
their duty of care in adopting the joint inventory procurement policy. The
implementation of the new policy was a reasonable business decision made with a
view to rectifying a serious and urgent business problem in circumstances in
which no solution may have been possible.
Impact of Québec Civil Code on Proceedings against Directors
The case having arisen in a civil law context within the Province of Québec,
the Supreme Court pointed out that the right of action was grounded in the
Civil Code of Québec (CCQ). Article 1457 of the CCQ, which sets out the
basic principle governing extra-contractual liability, states that "every person
has a duty to abide by the rules of conduct which lie upon him, according to the
circumstances, usage or law, so as not to cause injury to another."
The Court noted that Article 1457 should be read as having a broad and
inclusive meaning. As a result, it was clear that directors and officers come
within the expression "every person" and that the term "another" could include
creditors. What was left was to determine what "rules of conduct" were
applicable. In this case, the Court found that the duty of care set forth in
section 122(1)(b) of the CBCA constituted the applicable rules of conduct.
Three criteria must be met in order for a party to be held liable under
Article 1457 of the CCQ: a breach of the applicable rules of conduct, damages,
and a causal link between the breach and the damages. In this case, damages were
established but the court found that there was neither a breach of the
applicable rules of conduct nor evidence that the conduct in question was the
cause of the damages.
Although the creditors were ultimately unsuccessful, the interaction between
Article 1457 of the CCQ and Section 122(1)(b) of the CBCA provides a potentially
powerful additional remedy to creditors of a corporation and potentially other
interested parties in Québec to pursue claims for breach of duty of care
directly against directors. Creditors outside the Province of Québec in the
future may seek to assert a similar right of action for breach of the duty of
Reliance on Professional Advice
Directors have a defence under Section 123(5) of the CBCA to the extent that
they rely in good faith on a report of a person whose profession lends
credibility to a statement made by the professional person. In their defence,
the Wise brothers stated that, in implementing the joint procurement policy,
they had relied in good faith on the opinion of the vice-president of
administration and finance, an officer with a commerce degree and 15 years of
experience in administration and finance. However, he was not an accountant or
subject to the regulatory overview of any professional organization and did not
carry independent insurance coverage for professional negligence. The Supreme
Court held that he was not a "professional" as contemplated under Section 123 of
the CBCA and reliance on his advice did not give rise to a defence to a breach
of duty claim.
Oppression Remedy Highlighted
The Court did not consider the oppression or derivative remedies under the
CBCA as the bankruptcy trustee did not specifically seek those remedies.
However, the Court noted that the CBCA grants creditors a very extensive
oppression remedy under Section 241 of the CBCA with the broadest of creditor
remedies in any common law jurisdiction. The Court also noted that a creditor
may be a proper person to bring a derivative action in the name of the
corporation under Sections 239 and 240 of the CBCA as creditors' interests
increase in relevancy as a corporation's finances deteriorate.
The decision in Peoples v. Wise is a welcome clarification
on the part of Canada's highest court of the duties owed by Canadian directors.
It also highlights the importance of transparency, diligence, prudence and
process in reaching reasonable business decisions.