The Law on Fiduciary Duty and Conflict of Interest
In this article we will briefly examine a situation in which a director sits on two different, but industry-related, boards. Key concepts include: conflicts of interest, fiduciary duties, and duty to disclose.
Susan is a director for Company “A” and is also a director for Cooperative Association “B”. A, as a corporate entity, is designed to create value for its shareholders via the distribution of profits. B, as a cooperative association, is owned and democratically controlled by the members who use the services of, and receive benefits from, the association. In our example, A and B are not related but do operate in the same industry, the candy producing industry (“C”).
Because of A and B’s mutual involvement and interest in C there is a very real possibility for competition between the company and the cooperative association. For Susan, a director with legal responsibilities to both A and B, there is the very real possibility that a conflict of interest could arise.
Duties of Directors
Acting as a director comes with a great deal of responsibility. In British Columbia, under the Business Corporations Act [SBC 2002] c.57 (the “BCA”) and the Cooperative Association Act [SBC 1999] c.28 (the “CAA”), respectively, every director is legally obligated to act honestly and in good faith with a view to the best interests of their company or cooperative association. They must also exercise the care, diligence, and skill that a reasonably prudent individual would exercise in comparable circumstances. Together, these form the fiduciary duties which directors owe and were identified as such by the Supreme Court of Canada in Peoples Department Stores Inc. (Trustee of) v. Wise (2004 SCC 68) at paragraph 35:
The statutory fiduciary duty requires directors and officers to act honestly and in good faith vis-à-vis the corporation. They must respect the trust and confidence that have been reposed in them to manage the assets of the corporation in pursuit of the realization of the objects of the corporation. They must avoid conflicts of interest with the corporation. They must avoid abusing their position to gain personal benefit. They must maintain the confidentiality of information they acquire by virtue of their position. Directors and officers must serve the corporation selflessly, honestly and loyally: see K.P. McGuinness, The Law and Practice of Canadian Business Corporations (1999), at pg. 715.
Conflict of Interest
Included in the passage above is the requirement that directors “avoid conflicts of interest… [and] avoid abusing their position to gain personal benefit.” The director must exercise his or her powers in the best interests of the company as a whole and not for any improper or collateral purpose.
Conflict of interest rules, or disclosure rules, exist because directors do not live in a vacuum; they are members of a much larger community than that of the board on which they sit and as such they possess a number of external interests. As a result, although a director is supposed to, and indeed is legally obligated to, act with the best interests of their company or cooperative association in mind, they may be tempted to act in a way which is more beneficial to themselves or their business partners.
For a director like Susan acting as a director for two entities in the same industry, a conflict of interest may arise in a number of scenarios, including:
- if she were to personally contract with, or compete with, the company;
- if she facilitates contractual relations between the two entities of which she is a director (e.g. arranges for B to buy sugar for candy production from a company in which Susan is a major shareholder);
- if she makes a decision in which she favours the interests of A over B; or
- if she, in her capacity as director of either A or B, learns of an opportunity for profit that should have gone to the company but instead seizes the opportunity for her own benefit or the benefit of a third party (i.e. corporate opportunity).
Although a small measure of latitude exists for a director with respect to conflicts of interest, in determining whether any of the above hypothetical situations constitutes a breach of Susan’s fiduciary duty, the facts of the case would have to be examined. Indeed, as per Chief Justice Laskin in Canadian Aero Service Ltd. v. O’Malley (1974 SCC) at 620:
The general standards of loyalty, good faith and avoidance of a conflict of duty and self-interest to which the conduct of a director or senior officer must conform, must be tested in each case by many factors which it would be reckless to attempt to enumerate exhaustively.
Therefore, depending upon the facts and her actions, Susan may be required to make a formal disclosure of her interest to each of A and B, respectively. Any failure by Susan to announce her interest in an opportunity to the relevant board could be found to be a breach of the fiduciary duty she owes to both entities individually.
To Disclose or Not to Disclose, That is the Question
So as a director, what can you do to ensure that you do not breach your duties to the company or cooperative association for which you act?
The best practice is to disclose any conflicts of interest which may exist. If Susan discloses her conflict of interest in a timely fashion, she would not be found to be in breach of her fiduciary duties and would simply be disallowed from voting on any resolution related to the conflict.
If Susan failed to disclose her conflict of interest, she may be held responsible to the many different groups, including the company or cooperative association itself, its shareholders (via oppression or derivative actions), creditors (if the actions of the directors attract tortious liability), and could face sanctions such as damages including damages for negligence as well as injunctions against taking certain action.
Being a director of a company or a cooperative association includes many obligations and responsibilities. Caution must be exercised when carrying out your duties as a director, particularly if, like Susan, you act as a director on two different boards for entities operating in the same industry.
Being aware of your duties is the first step. If you have any questions about the duties of directors or officers, the lawyers at Pushor Mitchell LLP are here to help.