One of the main reasons that people incorporate their businesses is to shield themselves (and their partners and investors) from personal liability. And although the corporate structure does allow businesses owners to avoid liability in most circumstances, there are ways in which people within the corporation can be held personally liable when they do not fulfill their obligations.
Despite the fact that corporations are owned by the shareholders, it is typically the directors and officers who manage its day-to-day affairs. Due to this significant amount of responsibility, and the concomitant amount of harm directors and officers can do to shareholders and other stakeholders, the law tries to ensure that power is wielded responsibly. One way it does so is by imposing certain duties upon directors and officers which, if breached can cause those individuals to be held personally liable. The following are some circumstances in which this is the case.
- Fiduciary Duty. Fundamentally, directors and officers owe a fiduciary duty to act honestly and in good faith with a view to the best interests of the corporation. This duty prevents a director or officer from, among other things, competing with the corporation or putting his or her own interests before the interests of the corporation.
- Duty of Care. In addition to the fiduciary duty, directors and officers also owe a “duty of care” to the corporation, that is they must exercise the case, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. This duty requires that officers and directors have a minimum standard of business knowledge and competence, they must uphold a certain level of involvement and monitoring of the business’ activities, such as by keeping apprised of the corporation’s financial statements.
- Unpaid Wages. In order to protect employees from negligent business owners, the law imposes personal liability upon directors for up to six months of unpaid wages to employees upon bankruptcy or liquidation.
- Funds Improperly Distributed. Prior to distributing any funds of the corporation, directors must ensure that by distribution those funds, by way of dividends, for instance, the corporation is not putting itself in a position where it is unable to meet its debts as they become due, or where its liabilities exceed its assets. Any distribution in contravention of this rule can lead to personal liability for directors and officers.
In the face of these various ways of being held personally liable, the law also provides a number of avenues by which directors and officers can protect themselves from such liability.
From the corporation’s perspective, a corporation can indemnify a director and officer for their liabilities. Meaning the corporation can agree to pay a certain amount to a director or officer if they are held liable under these rules, subject to certain restrictions, such as the director must have been acting in good faith.
Corporations are also allowed to take out insurance (commonly referred to as directors’ and officers’, or “D&O” insurance) that pays directors and officers in the event they are held liable, again subject to restrictions.
But despite these methods of protecting directors nad officers, the best protection is for those individuals to be vigilant in the fulfillment of their duties, The following are some things for directors and officers to keep in mind:
Dissent: If a director or officer objects to a particular course of action, he or she can make their dissent known to the corporation and can have that objection recorded in the minutes.
Resignation: Where a course of action is particularly egregious or the liabilities particularly high, corporate law provides for a set out procedures allowing directors to formally resign from office. But directors and officers should be careful to consider how their resignation itself will affect the corporation’s financial performance.
Due Diligence: Reliance in good faith upon documents prepared by a professional advisor, such as a lawyer, accountant or engineer can be used as a defence by a director or officer facing a claim.