sources of liability and protection for the directors of...

Sources of Liability and Protection for the Direcan Insolvent Corporation Frank J.C. Newbould, Q.C. Presented at the Second Annual Advanced Insolvency Law Practice Conference, January 22, 2002

Statutory Deductions

There are a number of statutes which make directors liable for a co

failure to pay or remit funds and which in most cases make it an of

director if the corporation fails to remit the proper payments. Th

obligations to remit deductions for employee income tax, employmen

premiums, contributions to the CPP, GST and retail sales tax, va

holiday pay, employer health tax remittances, Ontario corpora

environmental protection obligations, occupational health and safety

etc. This paper is not intended to deal with those obligations which ar

well known, except to discuss techniques to relieve directors from the

those obligations in insolvency situations.

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Borden Ladner Gervais LLP
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Sources of Liability and Protection for the Directors of an Insolvent Corporation by F.J.C. Newbould


Lawyers • Patent & Trade-mark Agents www.blgcanada.com

2

Oppression Legislation

At common law it has generally been considered that directors owe their fiduciary

duties to the company as a whole and not directly to shareholders, employees or

other stakeholders. The response of modern business corporation statutes has

been to create an oppression remedy in order to provide some relief to these

persons for wrongdoing by those who control a corporation.

Section 247 of the Ontario Business Corporations Act is typical. It provides that

where a complainant can establish that the powers of the directors have been, or

threatened to be, exercised in a manner that is oppressive or unfairly prejudicial

to or that unfairly disregards the interests of any security holder (a shareholder),

creditor, director or officer of the corporation, a court can make an order rectifying

the matters complained of. A "complainant" means a security holder or former

security holder, a director, officer or a former director or officer and "any other

person who, in the discretion of the court, is a proper person".

It has been held that creditors may be complainants under this section and be

entitled to obtain relief against corporate directors. See Canadian Opera Co. v.

670800 Ontario Inc. (1989), 69 O.R. 2nd 532; aff'd (1990), 75 O.R. 2nd 720 and

Prime Computer of Canada Ltd. v. Jeffrey (1991), 6 O.R. 3rd 733. In both of

these cases, a creditor obtained a judgment against a director as a result of the

director taking steps to strip the assets of the company at a time when it was in

financial trouble.




3

Directors' Common Law Towards Duties to Creditors

Apart from statutory oppression remedies, our common law has moved towards

declaring that directors owe a fiduciary duty to the company's creditors when a

company is insolvent or near to insolvency. Professor Ziegel recently wrote that

over the past 20 years or so:

…British, Australian and New Zealand courts have repeatedly held, at least where a company is insolvent or near to insolvency, that the directors' duties lies not only towards the company's shareholders, but that they are also bound to act in the best interests of the company's creditors…. The aggregate effect of these developments is to change radically the traditional corporate law doctrine that the directors' duty is to promote the welfare of the company's shareholders and that creditors must be expected to look after themselves.1

(a) United States Position

It would appear that it was in the United States that the concept of a fiduciary

duty of a director to a corporation’s creditors first emerged. It has been said that

the origin of the rule can be found in the early part of the 19th Century.2

American corporate law, unlike our common law, provides that directors of

corporations owe a fiduciary duty to the corporations’ shareholders. A general

rule for insolvent corporations is that directors owe the same fiduciary duties to

1 CREDITORS AS CORPORATE STAKEHOLDERS: THE QUIET REVOLUTION – AN

ANGLO-CANADIAN PERSPECTIVE", (1993) 43 UNIVERSITY OF TORONTO LAW JOURNAL, 511; by Jacob G. Ziegel, Faculty of Law, University of Toronto.

2 See Millner, JOURNAL OF BANKRUPTCY LAW AND PRACTICE (Vol. 9) 201.




4

creditors as are owed by them to the corporation’s shareholders. In a leading

case in 1991, Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications

Corp. (1991), 17 Del. J. Corp. L. 1099, the duty was expanded and it was held

that the fiduciary duties owed by directors arose not just on the insolvency of a

corporation, but when a corporation was “operating in the vicinity of insolvency”.

In St. James Capital Corp. v. Pallet Recycling Associates, 589 N.W. 2d 511

(Minn. C.A.), it was stated “Generally, when a corporation is insolvent, or on the

verge of insolvency, its directors and officers become fiduciaries of the corporate

assets for the benefit of creditors. Snyder Elec. Co. v. Fleming, 305 N.W. 2d

863, 869 (Minn. 1981). This is because “as fiduciaries, they cannot by reason of

their special position treat themselves to a preference over other creditors.”

(b) Australia and the United Kingdom

The obligation by directors to consider, in appropriate cases, the interests of

creditors has been recognised in the High Court of Australia. In Walker v

Wimborne (1976) 137 CLR 1, the Court stated:

"… it should be emphasized that the directors of a company in discharging their duty to the company must take account of the interest of its shareholders and its creditors. Any failure by the directors to take into account the interests of the creditors will have adverse consequences for the company as well as for them"

It was further stated that:




5

"It is, to my mind, legally and logically acceptable to recognise that, where directors are involved in a breach of their duty to the company affecting the interests of the shareholders, then shareholders can either authorize that breach in prospect or ratify it in retrospect. Where, however, the interests at risk are those of creditors I see no reason in law or in logic to recognize that the shareholders can authorize the breach. Once it is accepted, as in my view it must be, that the directors' duty to a company as a whole extends in an insolvency context to not prejudicing the interests of creditors the shareholders do not have the power or authority to absolve the directors from that breach".

In England, the House of Lords approved this concept in Winkworth vs. Edward

Baron Development Co, Ltd. et al. [1987], 1 All E.R. 114 and in Liquidator of

West Mercia Safetywear Ltd. vs. Dodd & Anor (1988), 4 B.C.C. 30:

But where a company is insolvent the interests of the creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of the shareholders and directors to deal with the company's assets. It is in a practical sense their assets and not the shareholders' assets that, through the medium of the company, are under the management of the directors pending either liquidation, return to solvency, or the imposition of some alternative administration".

(c) Canada

These principles have recently been accepted in an action in the Quebec

Superior Court. In People's Department Stores Ltd. v. Wise (1998), 23 C.B.R.

4th 200, a subsidiary of a family controlled group of companies purchased

inventory and transferred it to the books of the parent without paying for it. Over




6

time the inter-company charge to the parent grew to over $18 million. The

parent's assets were secured to its banker. The subsidiary, and later the parent,

went bankrupt.

In an action by the subsidiary's trustee in bankruptcy against its directors, who

were also directors of the parent, it was held that section 122 of the Canada

Business Corporations Act, which provides that a director shall act honestly and

in good faith with a view to the best interest of the corporation, should be

interpreted to impose a duty on directors in favour of the company's creditors.

The company was embarking on a course of action which, the judge reasoned,

would inevitably in the short run render the company insolvent. Justice

Greenberg reviewed the English and commonwealth cases and concluded:

"… we are of the view, if the company is embarking on a course of action which will inevitably in the short run render it insolvent, as was the case here when Peoples embarked on the new domestic inventory procurement policy…only the creditors still have a meaningful stake in its assets. This will be obvious if the company has been formally declared bankrupt. Why should it make a difference that bankruptcy has been delayed for a period of time? If we accept the paramountcy of creditors interest when the company is insolvent, it must likewise be wrong, and a waste of economic resources, for the directors to continue to buy goods and services on credit knowing there is no reasonable prospect of the creditors ever being paid.

We agree."

In the People's Department Store Limited v Wise case, the action was brought for

damages caused by a breach of the directors' obligations under section 122 of




7

the CBCA and under section 100 of the BIA. No action was brought by the

trustee under the oppression provisions of the CBCA, and perhaps there was

some concern as to whether the trustee in the bankruptcy of a corporation could

assert a right under those provisions, as will be discussed below.

There are two recent Ontario cases in which it has been held at least at the

pleading stage that a director could be held liable to creditors for breach of a

fiduciary duty allegedly owing to creditors. In both cases single judges accepted

the principles adopted in People's Department Stores Ltd. v. Wise. See

Kenbrook Distribution Corp., v. Borins (1999), 45 O.R. 3rd 565 (Ground J.) and

Lakehead Newsprint (1990) Ltd. v. 893499 Ontario Ltd. (2001) 23 C.B.R. 4th 170

(Nordheiner J.). The principle accepted by these cases has not yet been the

subject of appellate comment. However, the writing is on the wall and one

should not assume that our appellate courts will buck the trend.

(d) To Whom Is The Duty Owed?

The question arises as to whether the fiduciary duty owed by directors to a

corporation’s creditors replaces the fiduciary duty owed to the corporation or is

merely added to it. If the duty were owed only to the creditors, it could

presumably be a breach of such duty if the directors acted to protect the interests

of other constituencies such as employees or shareholders.




8

In the United States, there are cases going both ways on this subject but the

prevailing view is that the fiduciary duty to creditors does not replace other

fiduciary duties of a director but merely adds to the duties.3

The prevailing view is stated in Geyer v. Ingersoll Publications 621 A.2d 784, 789

(Del. Ch. 1992):

“… the existence of the fiduciary duties at the moment of insolvency may cause directors to choose a course of action that best serves the entire corporate enterprise rather than any single group interested in the corporation at a point in time when the shareholders’ wishes should not be the directors’ only concern.”

The other views expressed in Federal Deposit Insurance v. Sea Pines 692 F.2d

973 (US CA, 4th Cir.) in which it is stated:

“However, when the corporation becomes insolvent, the fiduciary duty of the directors shifts from the stockholders to the creditors.

The law by the great weight of authority seems to be settled that when a corporation becomes insolvent, or in a failing condition, the officers and directors no longer represent the stockholders, but by the fact of insolvency, become trustees for the creditors, and that they then cannot by transfer of its property or payment of cash, prefer themselves or other creditors.”

In the People’s Department Store Limited v. Wise case in Quebec, the language

used by Justice Greenberg was “the paramountcy of creditors’ interest when the

3 Millner, supra, at p. 217.




9

company is insolvent”. Does that mean that the directors no longer owe a duty to

the corporation as a whole but only to its creditors?

The oppression provisions of the CBCA and OBCA suggest it should not,

because they provide for remedies if the directors disregard the interests of all of

the constituencies, i.e., the shareholders, creditors, directors or officers of the

corporation. Professor Ziegel quoted above suggests that the duty to act in the

best interests of the company’s creditors is an additional duty not replacing the

normal fiduciary obligations of directors.

(e) Extent of Duty Owed

What the reach of a director's duty to the corporation's creditors might be has not

yet been the subject of much guidance from the courts. We know from

oppression cases under the OBCA that if directors take steps to strip the

corporation of its assets in the face of outstanding obligations to its creditors, the

directors will likely be liable to the creditors for so doing. But there are other

issues remaining and the extent of a director’s fiduciary obligations to an

insolvent corporation’s creditors will undoubtedly be the subject of future case

law in Canada.

In People’s Department Stores v. Wise, in which the directors of the subsidiary

were directors and shareholders of the parent and in that sense benefited

indirectly from the transfer of inventory from the subsidiary to the parent, it was

held that their obligation as directors of the subsidiary was to properly administer




10

the subsidiary’s affairs so that its assets were not dissipated or exploited for their

indirect benefit to the prejudice of the subsidiary’s creditors. In other words, the

directors could not take steps to improve their shareholder interests at the

expense of the creditors. That is not a surprising result.

In the United States, as might be expected, there has been considerable debate

in the case law as to the extent of the directors’ duties to the insolvent

corporation’s creditors. While different courts have described the scope of the

fiduciary duty narrowly or broadly, it has been said that virtually all of the reported

decisions in which directors have been held accountable have involved directors

of insolvent corporations who have diverted assets for the benefit of insiders.4

In the Credit Lyonnais v. Pathe Communications case (supra), the bank had

financed MGM to enable MGM to emerge from Chapter 11 proceedings, and

under its security controlled the board of MGM while the loan was outstanding.

When MGM emerged from bankruptcy, but was still in the “vicinity” of insolvency,

the controlling shareholder demanded that the board of MGM sell assets to pay

down the loan so that control of the board would revert to the controlling

shareholder. The board refused. The chancellor of the Delaware Court of

Chancery held in favour of the board of directors who had been appointed by the

bank. He stated:

“But the MGM board or its executive committee had an obligation to the community of interest that

4 Bacon and Love, JOURNAL OF BANKRUPTCY LAW AND PRACTICE (Vol. 10) 185,

190.




11

sustained the corporation, to exercise judgment in an informed, good faith effort to maximize the corporation’s long-term wealth creating capacity.” (Underlining added.)

In Ben Franklin Retail Stores v. Steinberg 225 B.R. 646, an action by a

bankruptcy trustee against directors, alleging that they had wrongfully prolonged

the corporation’s life beyond the point of insolvency by misrepresenting the true

value of the accounts receivable in order to obtain corporation loans, was

dismissed. The directors’ fiduciary duties to the corporation’s creditors were held

to be limited to preventing directors from helping themselves at the expense of

the corporation. The court stated:

“On this theory, creditors have a right to expect that directors will not divert, dissipate or unduly risk assets necessary to satisfy their claims. That is the appropriate scope of a duty that exists only to protect the contractual and priority rights of creditors.

The “insolvency exception” to the general rule that directors owe no duty to creditors is, after all, an exception. Its scope should be no greater than the problem it was intended to solve. That problem is the risk that creditors’ rights would be defeated by directors’ who gave shareholders prior claims to assets. This is not to say that the duty could not be violated by causing the corporation to incur unnecessary debt to or for the benefit of shareholders. Subjecting assets to unwarranted claims is a way of diverting them from legitimate corporate uses. In an appropriate case, therefore, directors who cause their corporations to incur debt may be in breach of duties enforceable by creditors. This is not such a case.”




12

In the St. James Capital v. Pallet case (supra) an action by a creditor against

directors was dismissed. The defendant corporation, which was in severe

financial difficulty, received an offer to be bought for $10 million, which was more

than enough to repay the plaintiff and other secured creditors. However the offer

was withdrawn after the defendant breached a confidentiality agreement and

disclosed the terms of the offer. It was alleged that the directors breached their

fiduciary obligations to the corporation’s creditors by failing to maintain the

confidentiality of the offer, failing to complete a public offering of debt or equity

and by failing to liquidate the company’s assets in a commercially reasonable

manner. It was held that the fiduciary duty of directors was limited to a

prohibition against self-dealing or preferential treatment. The Minnesota Court of

Appeals stated:

“The directors and officers of an insolvent corporation do not have an affirmative fiduciary duty to complete a proposed public offering of debt or equity securities on behalf of the corporation nor do they have a duty to adhere to a strict confidentiality agreement regarding a proposed takeover of a corporation.

Absent self-dealings to the detriment of other creditors, the directors and officers of a corporation, once it becomes insolvent, are not transformed into a trust relationship and do not owe a legal duty to liquidate corporate assets in such a way as to minimize losses incurred by the corporation’s creditors.”

Directors have for some time been able to rely upon the business judgment rule.

To what extent will that rule continue to apply to claims by creditors against




13

directors? The business judgment rule is generally taken to have had its origin in

the United States. It provides that a court will not second guess the business

judgment of directors so long as a decision was taken in good faith with a view to

the best interest of the corporation and so long as it was made on an informed

basis and the directors did not have an improper interest in the transaction.

Directors obviously must act with prudence, and they cannot close their eyes to a

situation and later claim protection under the business judgment rule. See

generally C.W. Shareholders Inc. v. WIC Western International Communications

Ltd. (1998), 39 O.R. 3rd 755; Re Standard Trust Co. Ltd. (1992), 6 B.L.R. 2nd

241 and 347883 Alberta Ltd. v. Producers Pipelines Inc. (1991), 80 D.L.R. 4th

359.

In People's Department Stores Ltd. v. Wise, Justice Greenberg reviewed at

length the business judgment rule and concluded that it did not protect the

directors who had not acted prudently to protect the interests of the subsidiary

corporation from the interests of its parent corporation which they controlled.

Another issue that may arise is the obligation of directors of a corporation that

has made a proposal under the BIA or under the CCAA to put forward an even-

handed plan. To what end must the directors ignore the interest of the

corporation's shareholders in favour of its creditors? In the end it is the creditors

who will vote on the proposed plan of arrangement and who are normally

involved in negotiating its terms. Therefore, it can be argued, the creditors are in

a position to look after their own interests. Should the directors, however, be




14

required to ignore the interests of the equity holders in proposing the terms of the

plan? Some may consider it unrealistic and unnecessary to go that far.

In the United States, one commentator has discussed the directors’ obligations in

proposing a plan of reorganization in Chapter 11 proceedings and has suggested

that what the directors should do will depend upon whether they have a good

faith belief that the corporation can be rehabilitated:

“It is the gray area between liquidation value and going concern value which may be realized because of a chapter 11 reorganization that provides a potential interest for existing stockholders … The interests of stockholders should not prolong a chapter 11 case when it is patent that there is not, and there never will be, sufficient value to provide any consideration for the stockholders. However, so long as a debtor has a good faith belief that the corporation can be rehabilitated and that going concern value will be preserved and enhanced, the debtor and its directors have a duty to attempt to achieve a consensual plan of reorganization incorporating plan treatment for stockholder interests and junior creditor claims as contemplated by the Bankruptcy Code.”5 (Underlining added.)

This reference to a belief that going concern value will be preserved and

enhanced is very similar language to the Delaware Chancery Court in Credit

Lyonnais v. Pathe which stated that the directors should act in good faith to

maximize the corporation’s long-term wealth creating capacity.

5 Miller, CORPORATE GOVERNANCE IN CHAPTER 11: THE FIDUCIARY

RELATIONSHIP BETWEEN DIRECTORS AND STOCKHOLDERS OF SOLVENT AND INSOLVENT CORPORATIONS, 23 Seton Hall L. Rev. 1467, 1468, 1514-15 (1993).




15

(f) Need for a Common Law Fiduciary Duty of Care to Creditors

One may question why the imposition of a common law duty of care on a director

to its corporations' creditors is necessary in light of the oppression remedy

provisions of the OBCA, the CBCA and other provincial statutes (excluding

Quebec corporation legislation which does not have oppression remedy

provisions). The answer until recently may have been the decision in Attorney

General of Canada v. Standard Trust Co. (1991), 5 O.R. 3rd 660 in which

Houlden J.A. sitting as a single judge held that a trustee in bankruptcy of a

corporation could not be a complainant in an oppression action under

section 248 of the OBCA. This meant that it was in the interest of a trustee in

bankruptcy who could not use the statutory oppression remedy provisions to try

to establish a common law duty of care on the part of a director in favour of its

creditors.

However, in a recent decision in the Ontario commercial list, in Olympia & York

Developments Limited (Trustee of) v. Olympia & York Realty Corp. (2001), 16

B.L.R. 3rd 74, Farley J., did not follow the Standard Trust case but rather held

that a trustee in bankruptcy could be a complainant under section 248 of the

OBCA. The case is under appeal, but if this aspect of the decision is upheld, the

necessity in the future of establishing a common law obligation of a director to a

corporation's creditors may be of less importance.




16

Actions Against Directors for Corporate Acts

There are a number of recent decisions in the Ontario Court of Appeal dealing

with the right to sue directors and officers personally for actions which they

carried out as directors or officers of a corporation. The principle that has

emerged is that a director may be liable for acts performed as a director or officer

of the company if, absent fraud, deceit, dishonesty or want of authority, it can be

shown that the actions of the director were tortious. ADGA Systems International

Ltd. v. Valcom Ltd. (1999), 43 O.R. 3rd 101 and NBD Bank Canada v. Dofasco

Inc. (1999), 46 O.R. 3rd 514 are but two recent cases.

Many of the cases against directors involve the tort of negligent

misrepresentation. NBD Bank Canada v. Dofasco Inc. was such a case, in which

an officer of Dofasco and an officer and director of its subsidiary Algoma Steel

were held liable to one of the corporation's banks for negligently misrepresenting

to the bank the financial condition of Algoma. Algoma was in a financial crisis,

which was known to its bank. Contrary to what was represented to the bank,

however, Algoma’s U.S. subsidiary had no unsecured accounts receivable that

could be pledged to the bank. The bank allowed cheques to clear Algoma’s

account on the strength of the representations made. Within two weeks Algoma

filed under the CCAA.

While no representation was made that Algoma was solvent or that it would stay

in business, the bank was told that if the temporary advances requested to pay




17

the cheques exceeded the facility to be arranged, Algoma would pay the excess

from the proceeds it expected to receive from the sale of certain U.S. assets.

The trial judge took this to be misleading since it was dependent on Algoma still

being an operating and viable entity in control of its assets, and Algoma already

knew that it was insolvent and could be declared to be so. In effect, the trial

judge’s view was that if there was a serious risk of failure, there was a positive

duty to advise the company’s banker when seeking an accommodation.

Liability in the Dofasco case was not based on any notion of a fiduciary obligation

owing by directors or officers to a company's creditors, but on well-known

principles of a duty of care not to make misrepresentations negligently or

intentionally to someone who may rely on them. But it serves to remind officers

and directors that it is especially important to take care in exercising their

corporate duties when the corporation is in financial difficulty.

Drafting the CCAA Order to Protect Directors

(a) Initial Order

Unlike the BIA, which provides in section 69.31(1) for an automatic stay of

actions against a director once a corporation has filed a proposal under the BIA,

the CCAA provides in section 11.5(1) that the court may make an order under

section 11 of the CCAA staying an action against directors. Section 11.5

provides:




18

11.5 (1) An order made under section 11 may provide that no person may commence or continue any action against a director of the debtor company on any claim against directors that arose before the commencement of proceedings under this Act and that relates to obligations of the company where directors are under any law liable in their capacity as directors for the payment of such obligations, until a compromise or arrangement in respect of the company, if one is filed, is sanctioned by the court or is refused by the creditors or the court.

(2) Subsection (1) does not apply in respect of an action against a director on a guarantee given by the director relating to the company's obligations or an action seeking injunctive relief against a director in relation to the company.

(3) Where all of the directors have resigned or have been removed by the shareholders without replacement, any person who manages or supervises the management of the business and affairs of the company shall be deemed to be a director for the purposes of this section.

Normally, therefore, an initial order under the CCAA provides for a stay of

proceedings against directors during the stay period.

A typical stay order was made in the initial CCAA order in the Algoma Steel

restructuring on April 23, 2001. The order tracked the language of section

11.5(1) except that it was made in favour of “former, present or future” directors.

On a motion by creditors to vary this part of the order, an amendment was made

on June 8, 2001 removing the stay in favour of former directors. Section 11.5 of

the CCAA refers to a stay against “a director”, which presumably does not refer

to someone who was formerly a director but not so when the proceedings began.




19

In the initial CCAA order in Consumers Packaging Inc. made on May 23, 2001,

the stay ordered against directors also appeared to go beyond what is provided

for in section 11.5(1) of the CCAA in that it provided for a stay with respect to a

claim against the directors that arose both before and after the commencement

of the CCAA proceedings. Section 11.5 refers only to the stay of a claim that

arose prior to the commencement of the CCAA proceedings.

(b) Compromise of Claims Against Directors

Section 5.1 of the CCAA provides that a compromise in respect of a debtor

company may include a provision for the compromise of claims against directors

of the company that arose before the commencement of the CCAA proceedings.

The section provides:

5.1 (1) A compromise or arrangement made in respect of a debtor company may include in its terms provision for the compromise of claims against directors of the company that arose before the commencement of proceedings under this Act and that relate to the obligations of the company where the directors are by law liable in their capacity as directors for the payment of such obligations.

(2) A provision for the compromise of claims against directors may not include claims that

(a) relate to contractual rights of one or more creditors; or

(b) are based on allegations of misrepresentations made by directors to




20

creditors or of wrongful or oppressive conduct by directors.

(3) The court may declare that a claim against directors shall not be compromised if it is satisfied that the compromise would not be fair and reasonable in the circumstances.

(4) Where all of the directors have resigned or have been removed by the shareholders without replacement, any person who manages or supervises the management of the business and affairs of the debtor company shall be deemed to be a director for the purposes of this section.

Note that this section authorizes directors to be released only from certain

obligations as defined. It also provides that certain claims against directors may

not be compromised.

The scope of a compromise in favour of directors was recently the subject of

debate in re Canadian Airlines Corp. (2000), 20 C.B.R. 4th 1; leave to appeal

refused at 20 C.B.R. 4th 46. In the face of complaints against a form of release

broader than provided for in section 5.1 of the CCAA, Canadian Airlines agreed

that the form of release should have added to it "excluding the claims excepted

by section 5.1". Canadian Airlines also agreed to restrict the release to claims

that arose prior to the commencement of the CCAA proceedings, rather than

include claims up to the date of approval of the plan.

In Canadian Airlines, the court noted that while the section did not authorize the

release of claims against third parties other than directors, it did not prohibit such




21

releases either. However, without statutory authority, one may question how a

claim by a creditor against others may be compromised without the creditor

agreeing to it.

In the final order made in the Algoma proceedings on December 19, 2001, a

release was made in favour of past and present directors. The release in at least

two aspects appears to go beyond what is authorized in section 5.1 of the CCAA.

Firstly, the release that was ordered is a release against claims that any person

may be entitled to assert. This is an extraordinarily broad release as it purports

to encompass any person, whether or not such a person was not a party to the

proceedings or entitled to vote on the plan of compromise put to creditor classes.

Section 5.1 authorizes a compromise or arrangement to include a compromise of

claims against directors of the company, but it is difficult to understand how

someone not a party to the proceedings and not a party to the compromise could

have a claim against the directors legally released by such an order.

Secondly, the release included a release for claims arising prior to the

implementation of the plan – i.e., for claims arising after the commencement of

the CCAA proceedings. Section 5.1 of the CCAA authorizes a compromise of

claims that arose before the commencement of the CCAA proceeding but not

claims arising after the proceeding began.

The Algoma final order excluded claims from the release if a director is adjudged

by a final judgment on the merits to have committed fraud or wilful misconduct or




22

to have been grossly negligent. It also excluded any claim referred to in section

5.2 of the CCAA.

It has been suggested that section 5.1 of the CCAA and its companion

section 50.1(13) of the BIA were enacted in order to encourage directors of an

insolvent corporation to remain in office so that the affairs of the corporation

could be reorganized in a responsible way. However, one may question whether

the legislation will achieve its desired effect. While there may be an initial stay of

actions against a director, and while there may be a compromise of claims

against directors if the creditors accept such a plan, the legislation will be of no

effect if the compromise or arrangement with creditors is not accepted and the

corporation fails.

Moreover, a director may not be released from allegations of a misrepresentation

made by the director to creditors or from claims for oppression. Allegations of

oppressive conduct under the OBCA or CBCA give huge scope to any plaintiff's

counsel. The effect of the legislation in total would seem to allow a director to be

released from the potential obligations of a director set out at the beginning of

this paper for statutory deductions and the like but not for other serious

allegations.

(c) Security for Claims Against Directors

It is becoming common in CCAA proceedings to provide in the initial order for an

indemnity by the corporation in favour of its directors and to provide for security




23

against the corporation's assets to fund the indemnity. The legal basis for doing

so is unclear.

The initial order in the Algoma CCAA proceeding provided for an indemnity in

favour of directors and for security against the property’s assets ranking after a

number of prior charges against the indemnified liability. There was no stated

amount for the directors’ charge. After an attack on the directors’ indemnity and

charge was made by creditors, the order was amended on June 8, 2001. It

indemnified directors against claims prior to the commencement date of the

CCAA proceedings in relation to vacation pay and for all claims in relation to all

other matters arising after the commencement date. Note that the release

provisions in section 5.1 of the CCAA refer to the release of liabilities that arose

before the commencement of proceedings. The indemnity was much broader

than that. The amending order also limited the security to $55 million and made

clear that the indemnity and security were only to take effect after all recourse

had been made to any D & O insurance.

The initial order in the Consumers Packaging Inc. CCAA proceedings made on

May 23, 2001 also provided an indemnity in favour of directors and officers

against all liabilities "which may arise" out of their acting as such. No distinction

was made between claims which arose before or after the commencement of the

CCAA proceedings and the order expressly provided an indemnity for employee

remittances etc. arising before or after the date of the order. The order provided




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for a $20 million charge on the corporation’s property to secure the indemnity to

the extent that the directors and officers did not have D & O insurance.

The effect of such indemnities and security in the favour of directors is to

considerably broaden the protection in favour of directors beyond the kind of

release authorized by Section 5.1 of the CCAA. They apply to claims arising

after the commencement of proceedings and they apply whether or not a plan of

arrangement is ultimately accepted. They also mean that creditors have had

removed from them as available assets the amount of the security given to the

directors. In effect, the security authorized by the court provides the directors

with a preference for their new indemnity over the existing unsecured creditors of

the corporation.

sources of liability and protection for the directors of...

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