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THE FOLLOWING ARTICLE HAS APPEARED IN THE RECORD ON February 20, 2002

Corporate directors and officers, beware!



With the spotlight on the Enron collapse and just what the directors knew about the company's questionable practices, I can't think of a more appropriate occasion to write a column on the subject of corporate directors. I never doubted that being asked to serve on a board of directors was considered a great compliment. Now I am not so sure. Call me naive regarding corporate ethics, but until the Enron debacle began to unfold I was convinced that the first duty of a director was to act in the best interest of the corporation.

Apparently my perception of director responsibility is not entirely shared or understood. Just consider the number of directors and officers that have been hauled before the courts on grounds of mismanagement, fraud, negligence, self-dealing, inside trading, bid rigging, waste and conflict of interest.

Before zeroing in on their duties, let me begin by pointing out a few unexciting legal facts. They have to do with incorporated organizations including those, which are non-profit.

Incorporation status

In Canada, as in most other countries, companies are incorporated by letters patent, memorandum or articles granted by the federal or a provincial government. Once incorporated, a business takes on a separate and distinct legal status apart from the members or owners. It is this specific legal status that protects in principle the directors and officers from personal liability for the corporation's debts and other obligations.

By contrast, an unincorporated association is little more than an agreement between individuals that has no legal status. These organizations cannot sue or be sued. The members are personally liable to the creditors for the full amount of any debts and each member must sue or be sued individually. As with sole proprietorships and partnerships when forced in bankruptcy, all of the assets, both personal and business, are subject to being seized and sold to pay outstanding debts.

Non-profit organizations

Both our federal and provincial legislation also allow for the incorporation of organizations that encompass a variety of non-profit organizations and which are made up of members rather than shareholders. The vast majority exists primarily for the benefit of their members such as golf clubs, social clubs, and special interest organizations; they are supported in large part by membership-fees. Although fewer but not less important, are the many charitable associations which carry on activities that are primarily for the benefit of the public but which rely upon donations.

The main benefit achieved by the incorporation of non-profit organizations is that the members are not personally responsible for the debts of the corporation. Once incorporated, a nonprofit organization also becomes a separate and distinct legal entity possessing virtually the same powers as a for-profit corporation.

Duties of Directors

Those who agree to serve as directors or officers on non-profit organizations are prone to believe that their responsibilities are less demanding than those of a director of a business corporation. Not so- while it is true that profits are not the main objective and that there are no shareholders to appease, directors remain at all times accountable to both their members and constituents.

All about honesty and...

The most important legal obligation of a director is to act honestly, in good faith, and in the best interests of the corporation. As agents of their corporation, directors are required to subordinate their personal interests to those of the corporation and avoid conflicts of interest, a duty which seems to have been forgotten by some of the Enron executives. While managing the affairs of their organization, the directors also have a duty to exercise the "care, diligence and skill of a reasonably prudent person in comparable circumstances. They must also ensure that their corporation abides by the law as well as the corporation's letters patent, constitution and by-laws. Ignorance of the law does not absolve a director from any responsibility or liability.

Financial oversight is crucial

Financial oversight by directors of business and non-profit organizations is crucial. Due to their fiduciary liability, directors of non-profit organizations must be extra careful about how they raise and spend their funds. This applies to membership fees, proceeds from fundraising events and donations from the public. Government subsidies or grants are no exception. Failure to abide by any of the terms and conditions applicable to their eligibility, management and use can lead to criminal prosecutions.

Rules of conduct

Over the years, various rules of conduct have been laid down by our courts that have to do with directors. For example, even though board members may only sit formally once each quarter, they are expected to know what is going on within their organization. If having access to the books, records and financial statements of their corporation is essential, refusing to consult them can be tantamount to mismanagement. The classic defense of " I see nothing, I hear nothing,' carries no legal weight and is akin to willful blindness. When participating at board meetings, directors have a duty to come prepared and play a constructive role during the discussions. Before voting on a resolution, they are expected to consider all of the pertinent information and when necessary, obtain expert opinions. As for the day-to-day management, directors are required to formulate internal control policies and then do what is necessary to enforce them. Although they are entitled to delegate some of their powers they are nevertheless expected to exert reasonable control over their executive appointees.

With so many common sense principles, which have been reaffirmed, time and time again, in statutes and judgments, how is it that Enron type scandals continue to unfold before our very eyes? Certainly, not because of corporate directors and officers lacking in formal education, professional expertise or even knowledge of the law. At the expense of sounding over simplistic, it is all about greed, greed and more greed, an unfortunate human characteristic, which no law is capable of outlawing.