Supreme Court of Canada Confirms Directors' Fiduciary Duties Are Owed to the Corporation

Nov 10, 2004

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.

Background

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 other stakeholder.

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 circumstances.

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 care.

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.

Decision-making Guidance

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.