CORPORATE FINANCING

NOMINEE DIRECTORS

Norninee Directorsand Confidentiality:the Canadian LawPerspective

Jon FeldmanMichael PartridgeEric GoldbergGoodmans LLP

The increased level of shareholder acti-vism in Canada over the past several years hasaffected corporate governance in this countryin a number of ways. One consequence is thatit is more common for directors to be nomi-nated by a particular shareholder (we refer tothese directors as "nominee directors"), oftenas a result of successful proxy contests orsettlements of actual or threatened contests.The presence of nominee directors on a boardraises questions about the confidentiality ofboard deliberations and the dual, and poten-tially conflicting, obligations that nomineedirectors have to the corporation and thenominating shareholder.

In Canada, directors owe a fiduciary dutyto the corporation, not to individual share-holders. Canadian courts have also found thatinherent in this duty is a requirement fordirectors to maintain the confidentiality ofcorporate information they acquire as such.For nominee directors, these legal principlescan conflict with commercial realities as theyoften have competing duties or loyalties to thecorporation and their nominating shareholders.Canadian courts have consistently held thatwhen a nominee director faces such a conflict,their duty to the corporation prevails. Forexample, communicating confidential infor-mation to a nominating shareholder before ithas been generally disclosed may breach thenominee director's duty to the corporation.

This article discusses (i) the duties nomi-nee directors owe to a corporation and to thenominating shareholder, (ii) the circumstancesin which courts have found conflicts betweenthese duties that result in a breach of fiduciary

duty by the nominee director to the corpo-ration, and (iii) practical challenges thatnominee directors face when dealing withconfidential corporate information. This articlealso provides some considerations and bestpractices for nominee directors and corpora-tions with nominee directors on their boards.

Dual Loyalty of Nominee Directors

Under Canadian corporate statutes, direc-tors and officers have a fiduciary duty to "acthonestly and in good faith with a view tothe best interests of the corporation."' Thisobligation requires a director to subordinatehis or her personal interests to the bestinterests of the corporation. This duty is owedto the corporation as an entity distinct from itsshareholders and cannot be overridden byagreement or by the corporation's constatingdocuments.'-

Inherent in the fiduciary duty is anobligation to maintain and protect corporateinformation that is confidential or proprietary.3This obligation prevents directors from usingthis information to their own advantage.

Nominee directorships present a problemof dual loyalty. Nominee directors owe afiduciary duty to the corporation but alsohave relationships with, and sometimes dutiesto, their nominators. As a result, nomineedirectors might believe, and commercialrealities might imply, that they should sharematerial board information with nominating

I Canada Business Corporations Act, R.S.C. 1985,c. C-44 ["CBCA"], subsection 122(1)(a) and Ontario'sBusiness Corporations Act, R.S.O. 1990, Chapter B.16["OBCA"], subsection 47(1)(0.2 Peoples Department Stores Inc. (Trustee of) v. Wise,[2004] S.C.J. No. 64 at paragraph 35 ["Peoples"] andKevin P. McGuinness, Canadian Business Corpo-rations Law, 2nd ed. (Markham, Ontario: Lexis NexisCanada, Inc.), 2007 at 11.141 ["McGuinness"].3 The Supreme Court of Canada ("SCC") addressed theissue of a fiduciary's obligation to protect confidentialinformation in Lac Minerals Ltd, v. hztemationalComae Resources Ltd. In his decision, Mr. Justice LaForest implied that while a fiduciary duty does not arisein every relationship of confidence, the reverse isunlikely: "it is indeed difficult to conceive of anyfiduciary relationship where the right to confidentialitywould not exist with respect to such information." InPeoples. the SCC was more explicit, explaining thatdirectors "must maintain the confidentiality of infor-mation they acquire by virtue of their position."

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shareholders. While this information sharingmay be sanctioned by express or impliedconsent, or may not result in any harm to thecorporation, many boards worry about theprivacy of their meetings and deliberations andthe dissemination of confidential corporateinformation to nominating parties.

When a nominee director's duties conflict,the duty to the corporation must take prece-dence.4 These directors must do their best topromote the corporation's business and to actin good faith towards it. If the interests of thecorporation are subordinated to those of thenominating shareholder, nominee directorsmay be viewed as conducting the affairs of thecorporation in an oppressive manner.5 Courtshave found that when the interests of anominating shareholder and those of the cor-poration diverge, the disclosure of confidentialinformation by the nominee may constitute abreach of his or her fiduciary duty.6

When Duties Conflict

Although nominee directors have dualloyalties, being a nominee of a majorityshareholder does not in and of itself create aconflict or disentitle the director from votingon a contract in which its nominating share-holder has an interest.7 Nominee directorsare generally presumed to act in accordancewith their fiduciary duty to the corporationdespite competing allegiances. Notwithstand-ing these presumptions, Canadian courtshave generally found that nominee directorsbreached their fiduciary duties to the corpo-ration where they:

• failed to maintain an even hand;

• failed to analyze a course of action fromthe corporation's perspective; or

• failed to disclose information affecting the"vital interests" of the corporation.

4 AM v. Misir, [2004] 01 No. 5088 [Commercial List]at paragraph 57.5 Scottish Co-operative Wholesale Society Ltd. v.Meyer, [1959] 1 A.C. 324.6 Bennetts v. Board of Fire Commissioners of NewSouth Wales, (1967) 87 WN (Part 1) NSW 307["Bennetts"].7 Keating v. Bragg, [1997] N.S.J. No. 248 (N.S.C.A.) atparagraph 27.

Failure to Maintain an Even Hand

In serving the corporation, nomineedirectors cannot actively favour their nomi-nating shareholder over the corporation orother stakeholders. A fiduciary cannot act as a"champion and advocate of one party whomhe or she represents and contrary to theinterests of the others, but must at all timesmaintain an even hand."8

In the presence of conflicting interests, theOntario Court of Justice instructed nomineedirectors to actively disavow the interests oftheir nominator: The nominee director's obli-gation to his 'appointing' shareholder wouldseem to me to include the duty to tell theappointer that his requested course of action iswrong if the director in fact feels that way."9The Court acknowledged that voting against anominating shareholder could be contrary tothe nominee director's personal interests.However, directors must always vote with thebest interests of the corporation in minddespite these interests or instructions from anominating shareholder.10 The nominee mustact with the same commitment to the welfareof the company as an independent director.11

Failure to Analyze a Course of ActionFrom the Corporation's Perspective

When advocating a particular course ofaction, nominee directors must demonstratethat they conducted a reasonable analysis ofthe situation from the corporation's per-spective.

In Deluce Holdings Inc. v. Air Ganda,''the Court concluded that a nominee directorbreaches his or her fiduciary duties if ad-vancing the directive of a nominating share-holder is uppermost in his or her mind andminority shareholders are unfairly prejudiced.In the late 1980s, Air Canada had a strategy ofinvesting in regional carriers while permittingthem to exercise a certain degree of opera-tional independence. Air Ontario was oneexample. Air Canada owned 75% of the shares

8 McGuinness, supra note 2 at 11.203.9 820099 Ontario Inc. v. Harold E. Ballard Ltd., 1991CarswellOnt 142 at paragraph 106.I° Ibid.II Dairy Containers Ltd. v. NZ Bank Ltd., (1995) 7,NZCLC 96, 669 ["NZ Bank"].12[1992] O.J. No. 2382 (Ont. Ct. Gen. Div.).

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of Air Ontario and the De Luce family ownedthe remaining 25%. William De Luce wasnamed president.

By the 1990s, Air Canada had changed itsstrategy and sought to control its regionalcarriers. Despite receiving favorable reviews,William De Luce was told to resign byAir Canada representatives. When De Lucerefused, the Air Canada-controlled boardousted him. The Court determined that the AirCanada nominee directors too obviouslydisregarded the interests of other stakeholders.Whether there were sufficient reasons toterminate De Luce, the nominees failed toconduct such an analysis and were at all timesguided by Air Canada's -newly developedcorporate agenda. This behaviour was deemedoppressive and in breach of the nominees'fiduciary duty to Air Ontario.13

Failure to Disclose Information Affectingthe "Vital Interests" of the Corporation

Nominee directors have an obligation todisclose information in their possession that isdetrimental to the interests of the corporation.

In the 1993 decision of PWA Corp. v.Gemini, the Ontario Court of Appeal foundthat nominee directors cannot withhold infor-mation affecting a "vital aspect" of thecorporation's business." In 1987, PWA Corp.("PWA"), Air Canada and a third party formeda limited partnership ("Gemini") for thepurposes of operating a new joint reservationsystem. Each partner was allocated 33% ofGemini's units. The remaining 1% was allo-cated to the general partner, a corporationowned by the limited partners with a boardconsisting of nominees of the limited partners.After experiencing financial difficulties, PWAbegan secret negotiations with AmericanAirlines ("AMR"). An alliance with AMRwould eliminate PWA's need for Gemini.PWA's nominees never informed the Geminiboard of these developments.

The Ontario Court of Appeal found thatthe duties of the various nominee directorswere complex. The fact that PWA and AirCanada were sophisticated corporations andcompetitors meant that the nominees were

13 Ibid. at paragraph 57.14 PWA Corp. v. Gemini Group Automated DistributionSystems Inc., [1993] O.J. No. 1793 (C.A.) at 143.

under no duty to disclose strategies that woulddisadvantage their respective airlines. Yet, theCourt found that the PWA nominee directorsbreached their fiduciary duties by failing todisclose the part of their negotiations withAMR that would result in the loss of Gemini'shosting service. This would affect a vitalaspect of Gemini and result in a "serious lossto the partnership."15 Once PWA had decidedGemini was expendable, "its representativeson the board of the General Partner had anobligation to clearly indicate to the partnershipits desire to negotiate an exit."16

Handling ConfidentialInformation With Care

Where the interests of a nominating share-holder and those of the corporation diverge,the disclosure of confidential information bythe nominee may constitute a breach of his orher fiduciary duty. L7 Nominee directors mustprotect a board's confidential informationwhere the interests of the board and corpo-ration so require.18 A director must notcompromise or surrender his or her integrityand independence by favouring one group'sdistinct interests, 19 In other words, nomineedirectors cannot act as a mere channel ofcommunication or listening post on behalf ofthe groups or individuals that nominated them.

In Canada, there are statutory restrictionson what information can be accessed byshareholders. Subsection 144(1) of the OBCAoutlines a variety of corporate records thatshall "be open to inspection by the directors"during normal business hours.20 Included areaccounting records and records containingminutes of meetings and resolutions of thedirectors and any committee thereof.21 Sub-section 20(4) of the CBCA grants directorssimilar rights.22 However, pursuant to sub-section 145(1) of the OBCA, shareholders andcreditors of an OBCA corporation have nostatutory right to view accounting records orminutes of meetings and resolutions of the

15 Ibid. at 143.16 Ibid. at 144.17 Bennetts, supra note 6.18 Ibid., also cited by Kevin McGuinness in Halsbmy'sLaws of Canada — Business Corporations.19 Ibid.20 OBCA, ss. 140 and ss, 144.21 Ibid.22 CBCA, ss. 20(2) and ss. 20(4).

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directors and any committee.23 The CBCA hasa nearly identical provision.24 This suggeststhat the statutes view these documents asconfidential to the board.

The prospect of a nominee director passingconfidential corporate information on to anominating shareholder could be grounds for acorporation to withhold information from thatdirector. This was the case in Bennetts, wherea director requested classified information tofurther the interests of the group that electedhim.25 Bennetts, an Australian case and com-mon law authority on nominee directors, hasbeen widely cited by Canadian legal com-mentators. The New South Wales Board ofFire Commissioners was comprised of apresident and four members elected bydifferent groups. When the board's financecommittee wished to appeal a union award,one of the board members, who was also amember of the union, requested a documentrelied upon by the finance committee. Thepresident said he would make the documentavailable on an undertaking that its contentswould not be disclosed to the union.26 Theboard member rejected those terms andcommenced a suit arguing that the board wasnot entitled to refuse to produce the document.The Court found that a director has no right toview a classified document where the purposeis to carry out a misconceived duty in favourof an individual shareholder.27

However, there is Canadian case lawsuggesting that boards cannot bar access todocuments if there is mere speculation thedirector intends to improperly communicatethe information to shareholders. The BritishColumbia Supreme Court stated that if adirector is statutorily entitled to certaincompany information, the purpose for whichhe requests that information is irrelevant.28Similarly, the Alberta Court of Queen's Benchheld that directors are not required to statetheir purpose when requesting documents anddocuments cannot be withheld from directorswhen the alleged improper purpose, in that

23 OBCA, ss. 145( I ).24 See CBCA, ss. 20(2) and ss. 20(4).25 Bennetts, supra note 6.26 Ibid.27 Ibid.28 Johnston v. West Fraser Timber Co. Ltd., [1980]B.C.J. No. 1688.

case attempting to bolster a rival corporation,is a "leap in logic or at best, is speculative."29

These decisions do not completely fore-close the possibility that a corporation mightbe entitled to withhold information or docu-ments from nominee directors. The BritishColumbia Supreme Court cautioned that"should it ultimately be shown [that thedirector's purpose] is harmful or damaging,the respondent at that time perhaps might havea remedy."3° Thus, while the director's pur-pose may be irrelevant to whether they arestatutorily entitled to the information, thecorporation may be able to prevent access if itcan be proven that the director intends to harmthe corporation,

The law is also clear that a directorbreaches his or her fiduciary duties by ob-taining any property or business advantagebelonging to the corporation.31 Courts havefound that when nominee directors usecorporate information to profit on a personallevel, the breach is considered more severethan communicating confidential informationto nominating parties.32

Securities Law

Canadian securities laws, through insidertrading provisions, seek to prevent those in aspecial relationship with a reporting issuer,such as directors, from disclosing confidentialinformation.33 This practice is known as"tipping." For example, subsection 76(2) ofthe Securities Act (Ontario)34 provides that:

No reporting issuer and no person orcompany in a special relationship with areporting issuer shall inform, other than in the

29 Tyler v. Envacon Inc., 2012 ABQB 631 at paragraphs25 and 63.3° Ibid,31 Canadian Aero Service Ltd. v. O'Malley, [1974]S.C.R, 592.32 Levy-Russell Ltd. v. Tecmotiv Inc, [1994] O.J. No.650 (Ont. Ct. of Justice).33 According to section 76(5) of the Act, a "person orcompany in a special relationship with a reportingissuer" includes an insider, affiliate, officer and directorof a reporting issuer. It also includes any person orcompany that learns of a material fact or materialchange from another person in a special relationshipwith the reporting issuer and ought reasonably to haveknown that the other person was in such a relationship.34 R.S.O. 1990, Chapter S.5, s. 76(2) [the "Act"].

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necessary course of business, another personor company of a material fact or materialchange with respect to the reporting issuerbefore the material fact or material changehas been generally disclosed.35

Under section 1 of the Act, "material fact"is broadly defined as any fact that "wouldreasonably be expected to have a significanteffect on the market price or value of thesecurities."36 Similarly, "material change" in-cludes any "change in the business, operationsor capital of the issuer" that would have asignificant impact on the market price.37

Additionally, the Act explicitly referencesdecisions "made by the board of directors" toimplement such a change.38 Nominee directorsmust accordingly be mindful of their obli-gation not to disclose material undisclosedinformation to third parties — including his orher nominating shareholder.

The Ontario Securities Commission("OSC") has commented on the severe impactof tipping and the vulnerable position ofdirectors. In Rankin (Re),39 a case involvingillegal tipping by a Managing Director at RBCDominion Securities, the OSC outlined howboth the insider trading and tipping provisionsof the Act protect equal opportunity ofinvestors by preventing those with confidentialinformation from gaining an advantage.40Capital market efficiency and integrity isdamaged even when the tipper does not profitpersonally. The OSC imposed harsh sanctionson Rankin, including a permanent ban onbecoming a director or officer of a reportingissuer, to "ensure the future protection ofinvestors and capital markets by taking awayany opportunity Rankin may have to everagain engage in similar conduct."'"

Considerations and Best Practicesfor Nominee Directors, Shareholdersand Corporations

Nominee directors can minimize the riskof liability arising from their dual loyalties by

35 Ibid.

36 Ibid., s. 1..37 Ibid.33 Ibid.39 (2008), 31 OSCB 3303.4° Ibid. at paragraph 28.41 Ibid. at paragraphs 33 and 36.

following some of these suggested guidelinesand practices:

• refrain from actively favouring (or beingperceived as actively favouring) the in-terests of nominating shareholders wherethose interests conflict with those of thecorporation;

• conduct a reasonable analysis from thecorporation's perspective prior to advo-cating courses of action and maintainrecords of the analysis conducted and steps,taken;

• disclose information to the board affectingthe vital interests of the corporation;

• consider and comply with statutory limi-tations placed on information-sharing withshareholders; and

• inform nominating shareholders that direc-tors owe an overriding duty to the corpo-ration.

Nominating shareholders must also beaware of the potential liability associated withinducing a nominee director to breach his orher fiduciary duty to the corporation. WhileCanadian law is not well developed in thisarea, British and American cases have foundthat the general immunity of a nominatingshareholder does not apply where the share-holder interferes in the management of thecorporation or causes the directors to breachtheir duty towards it.42 The Ontario Court ofJustice has held that a director assuminga nominee role may be the beneficiary ofan implied undertaking by their nominatingshareholder to indemnify. Therefore, if anominating shareholder instructs or otherwisecauses such a breach resulting in damageto the corporation, the shareholder could beliable to the corporation for the lossesconcerned a3

Corporations can protect their confidentialinformation by adopting confidentiality poli-cies that restrict the flow of certain infor-mation to outsiders. Policies should be clear,concise and contain a carefully worded

42 McGuinness, supra note 2 at 11.148, citing KuivaitAsia Bank EC P. National Mutual Life Nominees Ltd.,[1990] 3 W.L.R. 297 at 319 (P.C.), per Lord Lowry andGetty Oil Co. P. Skelly Oil Co„ 267 A.2d 883 (Del. S.C:1970).43 Mogil P. Abelson, 1992 CarswellOnt 150.

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definition of "confidential information." Thisdefinition should encompass both materialnon-public information as well as informationthat is the subject of board meetings anddeliberations. If a confidentiality issue arises,the courts may look to the policy to determinehow the concept of "confidential information"has been defined and better assess the allegedbreach.44

It is also advisable to outline a clearstandard with respect to what information, ifany, nominee directors can disclose to theirnominating shareholders. Nominee directors

" In Disney v. The Walt Disney Co., 2005 Del. Ch.LEXIS 94, at 10-14 (Del. Ch. June 20. 2005), the Courtof Chancery gave significant weight to the fact that thecompany's confidentiality policy prohibited the dis-closure of certain information.

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should also be routinely informed of theirconfidentially obligations and the restrictionson insider trading and tipping.

While the increased presence of nomineedirectors on the boards of Canadian publiccorporations creates complexity and riskswhen it comes to• the dual, and potentiallyconflicting, obligations that nominee directorshave to the corporation and the nominatingshareholder, a well-informed board can takeappropriate actions to address this complexityand effectively mitigate these risks.