June 2005

Directors and Officers Fiduciary Duties Not Extended to Creditors
By Ramon Andal

When a corporation becomes insolvent or has entered the nebulous "vicinity of insolvency", one can expect litigation from corporate stakeholders aimed at holding directors and officers accountable for the losses. In Peoples Department Stores Inc. (Trustee of) v. Wise, 2004 SCC 68, the Supreme Court of Canada was asked by the corporation's trustee in bankruptcy to decide whether directors of a corporation owe a fiduciary duty to the corporation's creditors comparable to the statutory fiduciary duty they owe to the corporation.

Wise Stores Inc. acquired Peoples Department Stores Inc. from Marks and Spencer Canada Inc. The Wise brothers were majority shareholders, officers and directors of Wise Stores, and the only directors of Peoples. Because of covenants imposed by Marks & Spencer, Peoples could not be merged with Wise until the purchase price had been paid. The joint operation of Wise and Peoples did not function smoothly. Their inventory records were increasingly incorrect. To address the worsening situation, the directors of the two companies implemented a new joint inventory procurement policy whereby the two firms would divide responsibility for purchasing. Before the end of 1994, both Wise and Peoples declared bankruptcy. Peoples' bankruptcy trustee filed a petition against the Wise brothers, claiming that they had favoured the interests of Wise over Peoples to the detriment of Peoples' creditors, in breach of their duties as directors under s. 122(1) of the Canada Business Corporations Act ("CBCA").

Subsection 122(1) of the CBCA establishes two distinct duties to be discharged by directors and officers in managing, or supervising the management of, the corporation. The first duty has been referred to as the "fiduciary duty". This duty requires directors and officers to act honestly and in good faith with a view to the best interests of the corporation. The second duty is commonly referred to as the "duty of care". Generally speaking, it imposes a legal obligation upon directors and officers to be diligent in supervising and managing the corporation's affairs.

The Court observed that the statutory fiduciary duty requires directors and officers to act honestly and in good faith vis-à-vis the corporation. They must:

1. 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.
2. avoid conflicts of interest with the corporation
3. avoid abusing their position to gain personal benefit, and
4. maintain the confidentiality of information they acquire by virtue of their position.

For directors and officers, the fiduciary duty to the corporation arises from their relationship with the corporation that is marked by discretionary power and trust. The phrase the "best interests of the corporation" should be read not simply as the "best interests of the shareholders". From an economic perspective, the "best interests of the corporation" means the maximization of the value of the corporation. The Court accepted the principle that in determining whether they are acting with a view to the best interests of the corporation it may be legitimate, given all the circumstances of a given case, for the board of directors to consider the interests of shareholders, employees, suppliers, creditors, consumers, governments and the environment. However, the Court emphasized that "[a]t all times, directors and officers owe their fiduciary obligation to the corporation. The interests of the corporation are not to be confused with the interests of the creditors or those of any other stakeholders."

The interests of shareholders, those of the creditors and those of the corporation may and will be consistent with each other if the corporation is profitable and well capitalized and has strong prospects. However, this can change if the corporation starts to struggle financially. As the corporation approaches the "vicinity of insolvency", the residual claims of shareholders will be nearly exhausted:

While shareholders might well prefer that the directors pursue high-risk alternatives with a high potential payoff to maximize the shareholders' expected residual claim, creditors in the same circumstances might prefer that the directors steer a safer course so as to maximize the value of their claims against the assets of the corporation.

The directors' fiduciary duty does not change when a corporation is in the nebulous "vicinity of insolvency". In assessing the actions of directors, any honest and good faith attempt to redress the corporation's financial problems will, if successful, both retain value for shareholders and improve the position of creditors. If unsuccessful, it will not qualify as a breach of the statutory fiduciary duty.

The oppression remedy of s. 241(2)(c) of the CBCA and the similar provisions of provincial legislation regarding corporations grant the broadest rights to creditors of any common law jurisdiction. Section 241(2)(c) authorizes a court to grant a remedy if the powers of the directors of the corporation or any of its affiliates are or have been exercised in a manner that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer. Section 241 of the CBCA provides a possible mechanism for creditors to protect their interests from the prejudicial conduct of directors. According to the Court, the availability of such a broad oppression remedy undermines any perceived need to extend the fiduciary duty imposed on directors by s. 122(1)(a) of the CBCA to include creditors. The trustee did not seek an oppression remedy.

In light of the availability both of the oppression remedy and of an action based on the duty of care, stakeholders have viable remedies at their disposal. There is no need to read the interests of creditors into the duty set out in s. 122(1)(a) of the CBCA. Moreover, in the circumstances of this case, the Court found that the Wise brothers did not breach the statutory fiduciary duty owed to the corporation.

Directors and officers will not be held to be in breach of the duty of care under s. 122(1)(b) of the CBCA if they act prudently and on a reasonably informed basis. The decisions they make must be reasonable business decisions in light of all the circumstances about which the directors or officers knew or ought to have known.

The implementation of the new inventory policy was found to be a reasonable business decision that was made with a view to rectifying a serious and urgent business problem in circumstances in which no solution may have been possible.