Recent developments in director and officer liability

The Fighting Against Forced Labour and Child Labour in Supply Chains Act

Brought into force on January 1, 2024, the Fighting Against Forced Labour and Child Labour in Supply Chains Act (the Act) underscores Canada’s international commitment to fighting against modern slavery by creating reporting obligations for many larger Canadian corporations that are carrying out certain described activities (producing goods anywhere in the world, importing goods into Canada, or controlling an entity that does these things).

The relevance of the Act for directors is twofold: (i) directors must approve the report each year before it is filed; and (ii) directors face personal liability if the entities they serve do not comply with the Act’s reporting obligations. Such liability includes a fine of up to $250,000 for an individual director.

Initial reports are due by May 31, 2024; however, federally incorporated companies are required to provide the report to shareholders alongside their annual financial statements. This accelerates the reporting deadline for such companies so that the delivery of the report aligns with the distribution of their financial statements to shareholders.

Directors should discuss with management their plans for developing the report for review by the directors. They should also consider their director and officer insurance policies and whether they cover fines or penalties under the Act. Although many primary policies do not cover fines and penalties, they are often covered in excess policies that contain coverage exclusively for directors and not the company (so-called side-A only policies).

To learn more about the Act, read our summary of the government’s guidance on the Fighting Against Forced Labour and Child Labour in Supply Chains Act, as well as our breakdown of key clarifications from the Minister of Public Safety and Emergency Preparedness.

Caremark duties

A recent decision from the U.S., Segway Inc. v Cai¹, reminds us that Caremark duties could ultimately be determined to exist for directors of Canadian entities. Caremark duties are an oversight requirement of directors under Delaware law, named after the landmark decision where these duties were in part articulated². Oversight liability can be established where fiduciaries (i) “utterly fail to implement any reporting or information system or controls”, or (ii) “having implemented such a system or controls, consciously fail to monitor or oversee its operations”, which disables them “from being informed of risks or problems requiring their attention”. This second prong of the Caremark duties is commonly referred to as a “red flag” claim, on the basis that the directors ignored red flags generated by the information system. Subsequent case law has established that Caremark duties extend to officers as well³, and, as Segway v. Cai notes, the pleading standards are just as high for officers as they are for directors (that is, needing in effect a finding of bad faith on the part of directors and officers).

No Canadian decision has yet explicitly found an equivalent oversight duty that aligns with the Caremark duties. However, it seems like only a matter of time before a Canadian judge rules that such oversight duties exist as part of a Canadian director’s duty of loyalty and good faith and duty to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. Furthermore, Canadian directors are required to manage, or supervise the management of, the business and affairs of a corporation, language which sounds very similar to what’s outlined in the Caremark duties.

Whether or not Caremark duties are formally implemented in Canada through the courts, directors should ensure that reporting or information systems and channels exist within the company up to the board of directors, whose systems should also be audited from time to time. This should include ensuring that any “red flags” that arise are immediately brought to the attention of the board for resolution.

D&O insurance: bankruptcy exclusions

A disturbing new trend of bankruptcy exclusions has started to emerge in director and officer insurance policies. The intent of such a device in an insurance policy is to exclude from coverage all claims arising from the bankruptcy or insolvency of the company the directors serve. The use of such an exclusion would be a terrible outcome for directors, given that bankruptcy or insolvency is the circumstance where it is most crucial to have insurance coverage in place. As an alternative to a bankruptcy exclusion in an insurance policy, we have also seen bankruptcy sub-limits, limiting the amount of coverage in place to a fraction of the overall coverage for insolvency-related claims.

Directors should strongly resist the insertion of such exclusions or sub-limits in a director and officer insurance policy; in fact, it is worth discussing whether an insurance policy that contains such exclusions or sub-limits is even worth pursuing. Alternatively, they should determine whether the company has a side-A only policy—that is, an excess insurance policy available only to directors and officers, which does not contain bankruptcy exclusions or sub-limits as described above.