Authors: Jeremy Fraiberg and Alex Gorka

Directors’ duties

The corporate statutes in Canada impose two principal duties on directors: the fiduciary duty and the duty of care. Directors cannot contract out of these responsibilities and may be held personally liable for any breach of these duties

Fiduciary duty

Directors are fiduciaries of the corporation they serve. This long-standing principle is codified in the corporate statutes by the requirement that directors act “honestly and in good faith with a view to the best interests of the corporation” in exercising their powers and discharging their duties.

The Supreme Court of Canada set out the scope of the fiduciary duty in its decision in BCE Inc. The key principles from the decision are as follows:

• The fiduciary duty is owed to the corporation, not to any particular stakeholder.
• The fiduciary duty of the directors is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an ongoing concern, it looks to the long-term interests of the corporation. The content of this duty varies with the situation at hand.
• In considering what is in the best interests of the corporation, directors may look to the interests of, among others, shareholders, employees, creditors, consumers, governments and the environment to inform their decisions.
• The duty of the directors to act in the best interests of the corporation comprehends a duty to treat individual stakeholders affected by corporate actions fairly and equitably based on those stakeholders’ objectively determined reasonable expectations.
• Where stakeholders’ interests conflict, there is no principle that one set of interests should prevail over another set of interests. In particular, unlike the Revlon duties under Delaware law, there is no principle that shareholder interests in maximizing shareholder value prevail over other stakeholder interests in a change-of-control transaction. Everything depends on the particular situation faced by the directors and whether, having regard to that situation, they exercised their business judgment in a responsible way and resolved any conflicting interests fairly and equitably based on an objective determination of such stakeholders’ reasonable expectations.

Although BCE did not specifically endorse a duty to maximize shareholder value, shareholders obviously have a great deal at stake in a change-of-control transaction, and have a reasonable expectation that directors will give considerable weight to shareholders’ interests when considering how to respond to an acquisition proposal. Accordingly, determining whether an acquisition proposal delivers the best value reasonably available to shareholders should remain a central focus of directors’ deliberations. This is all the more important since shareholder approval is required to complete a transaction, and most Canadian corporate statutes provide shareholders with the ability to bring a claim against a corporation and its directors alleging oppressive conduct if shareholder interests have been unfairly disregarded.

Duty of care

In discharging their duties, directors must also “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.” This standard of care can be achieved by any director who devotes reasonable time and attention to the affairs of the corporation and exercises informed business judgment. The standard of care is measured against the objective standard of what a reasonably prudent person would do in comparable circumstances. Failure to meet the standard often stems from passivity and a failure to inquire.

In BCE, the Supreme Court of Canada confirmed the existence of a Canadian “business judgment rule” under which courts will defer to directors’ business decisions so long as they are within a range of reasonable alternatives. Courts defer to decisions of directors taken in good faith in the absence of conflicts of interest, provided the directors undertook reasonable investigation and consideration of the alternatives and acted fairly. Courts will not subject directors’ business judgment to microscopic examination and will not substitute their view for that of the directors, even if subsequent developments show that the directors did not make the best decision.

Formation of a special committee

In discharging the duty of care, a threshold consideration is whether a board should constitute a special committee of independent directors to review and consider a take-over bid or credible acquisition proposal.

Where there is a true conflict transaction that engages the procedural protections contained in MI 61-101 (e.g., because the potential acquiring party is a related party of the target company), then a special committee of independent directors with independent legal and financial advisors should be, and may be required to be, established to review an acquisition proposal, supervise and direct any negotiations and make recommendations to the board.

In other circumstances where the conflict is not as acute, such as where there is a perception that management may be influenced by considerations relating to their continued employment, the board will need to consider how best to address the conflict. In some cases, the conflict may be addressed by excluding management and any potentially conflicted director from those portions of the board’s deliberations as considered appropriate in the particular circumstances.

In other cases, the board may choose to establish a special committee. Canadian courts have looked favourably upon the establishment of special committees as a means of addressing potential conflicts.

A special committee may also be desirable as a matter of convenience, depending on the relative expertise of the directors and their differing time commitments and availability.

Although BCE did not specifically endorse a duty to maximize shareholder value, shareholders obviously have a great deal at stake in a change- of-control transaction, and have a reasonable expectation that directors will give considerable weight to shareholders’ interests when considering how to respond to an acquisition proposal.

Oppression remedy

Under the oppression remedy, courts are granted broad remedial powers if a court is satisfied, among other things, that the powers of the directors have been exercised in a manner “that is oppressive or unfairly prejudicial or that unfairly disregards the interests of any security holder.” Although it is not necessary for an oppression remedy complainant to establish that directors have breached their fiduciary duty in order to succeed in an oppression claim, demonstration of compliance with the board of directors’ fiduciary duty is of valuable assistance towards protecting the board of directors against such claims.

The objective of the remedy is to protect the reasonable expectations of shareholders and other stakeholders, giving the court (as described in BCE) “broad, equitable jurisdiction to enforce not just what is legal but what is fair.” In determining whether a particular decision of a board was oppressive, the court must necessarily assess the impact of the business decision made by the board.

If a court finds oppression, it may make any order it considers appropriate to remedy an oppressive or unfair situation.

Where a company has debt or equity securities outstanding that are not subject to the offer to acquire, particular care needs to be taken to ensure that the interests of holders of such securities have been fully considered.

Directors’ actions in response to an acquisition proposal

In light of the foregoing principles, in formulating a response to an acquisition proposal, the directors must be able to demonstrate that they exercised their judgment on an informed basis, after reasonable investigation and analysis of the situation and with a reasonable basis for believing that their actions are in the best interests of the corporation. There is no absolute duty to negotiate with a potential acquiror or to conduct a process designed to achieve a sale of the corporation simply because the corporation has received an acquisition proposal.

Assuming the board concludes that it is in the best interests of the corporation to explore a potential sale of the corporation, there is no single blueprint that the board must follow. The board has broad latitude under the business judgment rule in designing a sale process, provided that the board acts on an informed basis. Typically this will involve receiving the advice of the corporation’s financial and legal advisors.

Accordingly, the board could choose to engage with a potential acquiror on an exclusive basis, without conducting any form of pre-signing market check of other potential buyers or running an auction. Alternatively, the board may decide that a pre-signing market check is advisable in the circumstances. The board could also consider running an auction, although it is under no legal obligation to do so. The board’s judgment will be informed by, among other things, the terms of any acquisition proposal, whether the potential acquiror demands exclusivity as a condition of continuing negotiations, the universe of other potentially interested buyers, the impact of the process on the corporation’s business and what process is reasonably calculated to lead to the best outcome for shareholders and the corporation’s other stakeholders.

Where the corporation is the subject of a hostile take-over bid, the same principles apply. There is no obligation for the corporation to put the company up for sale. However, given the reality that shareholders will ultimately have the ability to tender to the bid, directors will need to consider a variety of alternatives to maximize shareholder value, including staying independent, a potential sale to another party, or a higher bid from the hostile bidder.

Deal protections and defensive tactics

In Canada it is customary to include deal protection measures in the arrangement agreement or support agreement (in the case of a take-over bid) and for boards to adopt certain defensive tactics in response to hostile bids. These deal protections and defensive tactics may be reviewed by one or more of the courts, the securities regulators or by the applicable stock exchange (in the case of issuance of shares or rights to acquire shares). Challenges to the exercise by the target board of its fiduciary duty and duty of care will typically be made in court, as the board owes its duties to the corporation under applicable corporate law. Notwithstanding that the court is the appropriate forum to determine whether the directors have complied with their duties, the securities regulators retain a broad discretionary power to review the actions of the target board as part of their mandate to protect the capital markets. The securities regulators have issued guidance under National Policy 62-202 – Take-over Bids-Defensive Tactics, in which capital market participants are advised that the regulators are prepared to examine target company tactics in specific cases to determine whether they are abusive of shareholder rights.

Common deal protections in supported transactions include non-solicitation (“no shop”) provisions, in which the target company agrees not to solicit or negotiate other offers, as well as a commitment to recommend the supported transaction and pay a break fee if the agreement is terminated in certain circumstances. The non-solicitation provisions generally permit the board in the exercise of its fiduciary duties to engage with a rival bidder that makes an unsolicited acquisition proposal that is likely to result in a superior proposal. The “fiduciary out” of the board of directors also typically permits the board to change its recommendation and enter into an agreement to support a superior proposal. What constitutes a superior proposal is a matter of negotiation, but it is almost invariably defined to include a requirement that the acquisition proposal is more favourable from a financial point of view to the target shareholders than the existing transaction. A break fee is permissible under Canadian law, provided that it represents a reasonable commercial balance between its negative effect as an auction inhibitor and its potential positive effect as an auction stimulator (including if the fee was necessary in order to induce a bid). Break fees typically range from 2% to 4% of deal equity value.

In defending against hostile bids, target boards have also employed a number of defensive tactics. The most common is the use of rights plans or poison pills, which were previously discussed. Additional defensive tactics include issuances of treasury securities to dilute the bidder or potential bidder (often by placing the securities in friendly hands), the sale of assets, recapitalizations and asset lock-ups.

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• Competition law and foreign investment review