Comment Letter regarding The Ontario Government’s Expert Panel report: Business Law Agenda

The Institute of Corporate Directors Comment Letter regarding The Ontario Government’s Expert Panel report, Business Law Agenda: Priority Findings and Recommendations Report

Introduction

The Institute of Corporate Directors is a national organization with over 10,000 members concerned principally with helping to improve the performance of boards and businesses across Canada and, by extension, our national economic performance. As a key centre of Canada’s capital markets and a significant driver of much of our country’s economic activity, improving the global competitiveness of Ontario business benefits the broader Canadian community.
 
We welcome the Ontario Government’s commitment to enhancing the province’s attractiveness as a venue for business and we agree that much can be done to dismantle barriers that make it less so. To that end, our comment letter supports the objective of the project and makes three specific points as well as one general comment that we believe the Minister may wish to consider as he advances this important initiative.

Consulting with Ontario business

The panel convened by the Minister is a highly experienced one and their recommendations will, appropriately, be closely considered. If the results of this initiative are intended to foster prosperity, create jobs, spur innovation and support long-term economic success for the province, we urge the Government to also solicit the insights of Ontario business in a more formal and direct way.
 
We understand that, through this consultation, the Government will receive feedback from business stakeholders but note that this feedback may relate mostly to the recommendations of this panel and may not address all of the changes that Ontario businesses feel would be accretive to their organizations and the province’s economic growth and competitiveness.
 
A formal consultation would allow the Government to better understand what businesses perceive to be the barriers to their own competitiveness. Most importantly, this would help ensure that any legislative changes that result from this initiative align with the needs of  the entrepreneurs, investors, managers and directors of Ontario’s public and private companies that create employment and wealth in the province.

3.2 (ii) Providing greater certainty about the standards to which directors and officers will be held, the liabilities to which they are exposed and the defences and protections available to them
 
Directors of Ontario companies must be allowed to exercise their fiduciary duty with clear understandings of the applicability of their due diligence defences and the limits to their liability. We agree with the panel’s recommendation that greater certainty must be brought to the due diligence defence and liability regimes governing directors and officers in Ontario and urge the Government to prioritize this in their Business Law Agenda.
 
Recent actions have eroded due diligence defences in Ontario, negatively impacting the province’s reputation for fair play and predictability and acting as a disincentive for experienced leaders to serve on boards in the province. Below we offer greater context regarding this erosion and the impact this has had in Ontario and offer recommendations on how this may be addressed in legislation.

Context 

One of the most egregious examples of the erosion of directors due diligence defenses is that of Northstar Aerospace (Canada). In that case, the Ontario Ministry of the Environment and Climate Change (MOECC) issued an Order to a group of former directors of Northstar, a bankrupt entity, to personally fund remediation of the site of a former Northstar manufacturing site in Cambridge, Ontario. This Order was issued despite acknowledgment from the MOECC that the former directors were not personally responsible for the discharge of contaminating chemicals. Evidence also indicated that the contamination likely pre-dated Northstar’s occupation of the site. Despite this, officials argued that the directors had “management and control” of the company as per S.18 of Ontario’s Environmental Protection Act (EPA). 

The group of former directors agreed to a settlement, which saw them personally pay $4.75 million. This Order was non-refundable meaning that even if it was overturned on appeal there was no reasonable prospect of reimbursement for the directors’ legal costs and the costs they had already borne (and would continue to bear) to remediate the site. The costs of fighting the appeal were larger than the costs of settling. 

Northstar has proven to be a precedent case. In the time since that settlement (2013), the MOECC has issued Orders to directors of other companies to remediate sites, knowing that the cost of complying with these non-refundable Orders will incentivize settlements. Canada’s director community is very concerned that the MOECC is taking advantage of a lack of clarity in the law to erode due diligence defences and negatively impact Ontario’s reputation and, potentially, its economy. 

Issues of concern 

Canadian corporate law imposes a duty of care on directors of publicly-traded companies. This duty of care requires directors to exercise the care, diligence and skill that a reasonably prudent person would have exercised in a comparable situation. By pursuing the directors through non-refundable Orders in the absence of any fault on their part, the MOECC has effectively nullified due diligence defences in certain cases. In effect, the MOECC is imposing potentially unlimited liability on directors – past and present - of companies that have ever owned or occupied land in Ontario that turns out to be contaminated, regardless of whether they were at fault or negligent. 

In the case of Northstar, the MOECC’s claim that the former directors had “management and control” and as such were responsible for failing to ensure provisions were put in place to mitigate and remediate the contamination of the site contradicted basic standards of corporate governance. This claim was based on the MOECC’s interpretation of EPA S.18., which refers to “a person who owns or owned or who has or had management or control of an undertaking or property […]”. The “reasonable care” outlined in EPA S. 194 is the standard of care that should apply to independent directors in their usual and proper role, which does not include the operational management of the company (i.e. the “management and control” outlined in EPA S.18). Simply put, basic corporate governance dictates that independent directors do not manage or control the companies they serve, they oversee management. 

In a recent internal survey, 97% of ICD members who are public company directors stated that the recent imposition of unlimited liability through MOECC Orders would be a factor when considering whether to sit on the board of a company involved in heavy manufacturing; 96% would consider the imposition of unlimited liability when deliberating over large investments in Ontario. 

In short, the lack of clear rules around director liability in Ontario acts as a disincentive for companies to invest in Ontario or occupy land that may be contaminated, such as Brownfield sites. This may have a direct and negative impact on the Ontario economy and employment growth in the province. 

Furthermore, the lack of clarity may lead to fewer qualified leaders willing to take on board roles – particularly in industries that have been targeted such as heavy manufacturing.

Addressing the problem 

Two mechanisms could ameliorate or remedy this situation: 

As a first step, the Minister of Environment and Climate Change can immediately issue a Ministry Compliance Policy to provide guidance to ministry staff in exercising their authorities under the Environmental Protection Act. Such a policy would direct staff to not issue Orders to directors of companies who are compliant with S.194 of the EPA (Duty of director or officer): 

194. (1) Every director or officer of a corporation has a duty to take all reasonable care to prevent the corporation from, 

(a) discharging or causing or permitting the discharge of a contaminant, in contravention of, 

(i) this Act or the regulations, or 

(ii) an environmental compliance approval, certificate of property use, renewable energy approval, licence or permit under this Act; 

(b) failing to notify the Ministry of a discharge of a contaminant, in contravention of, 

(i) this Act or the regulations, or 

(ii) an environmental compliance approval, certificate of property use, renewable energy approval, licence or permit under this Act; 

(c) contravening section 27, 40, 41 or 47.3 in respect of hauled liquid industrial waste or hazardous waste as designated in the regulations relating to Part V; 

(d) contravening section 93 or 184; 

(e) failing to install, maintain, operate, replace or alter any equipment or other thing, in contravention of an environmental compliance approval, certificate of property use, renewable energy approval, licence or permit under this Act; or 

(f) contravening an order under this Act, other than an order under section 99.1, 100.1, 150 or 182.1. 2005, c. 12, s. 1 (65); 2009, c. 12, Sched. G, s. 25; 2010, c. 16, Sched. 7, s. 2 (89-91). 

and who act in accordance with S.134 of the Ontario Business Corporations Act (Standards of care, etc., of directors, etc.)

134. (1) Every director and officer of a corporation in exercising his or her powers and discharging his or her duties to the corporation shall, 

(a) act honestly and in good faith with a view to the best interests of the corporation; and 

(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. R.S.O. 1990, c. B.16, s. 134 (1); 2006, c. 34, Sched. B, s. 24. 

Following this, we recommend amending those sections of the Environmental Protection Act, which already protect fiduciaries, municipalities and secured creditors, such as S. 168.23 (Obligations of fiduciaries) to also include directors. 

3.2 (iii) Allowing shareholders to effectively determine the composition of their boards of directors by eliminating certain legislative requirements 

25% rule 

We believe that every director should play a meaningful oversight and leadership role in the companies they serve. As such, it is important to underscore that Canada has a number of highly skilled and trained corporate directors, well versed in the highest standards of corporate governance. It should not be difficult for companies – foreign or otherwise - to find such professionals. 

The rationale behind the recommendation to amend the Ontario Business Corporations Act (OBCA) to eliminate the 25% Canadian director residency requirement is driven by the fact that some other jurisdictions in Canada such as British Columbia and Quebec do not have this requirement. The assumption is that by eliminating this rule more multinational corporations will incorporate in Ontario or establish subsidiaries. 

Prior to proceeding with any amendment, we believe that the government should weigh the benefits against other considerations. Non-Canadian directors may have less insight into the social and economic fabric and priorities of the province, potentially resulting in corporate decisions and investments that do not benefit Ontario in the long term. In addition, retaining some residency requirement will provide an ongoing Canadian connection to the province in the event of offshore issues impacting an Ontario incorporated company

Voting against directors 

The ICD believes that majority voting policies are a best practice and we support the recent TSX rule mandating such policies for issuers listed on its exchange. 

Regarding the recommendation to amend the OBCA to allow shareholders to vote against candidates for election to the board (as opposed to the current practice of withholding votes), we urge caution. Through the TSX, the ability to vote “for” or “against” (“withhold” within a majority voting policy) a director is already provided for. Within a majority voting policy, the board must accept or refuse (but only in exceptional circumstances) a tendered resignation within 90 days of the meeting. 

Changing corporate law to include a “no” vote option, however, requires a great deal of reflection to avoid unintended consequences. 

Whereas with majority voting policies boards have the flexibility to manage the consequences of a failed election in the best interests of the corporation and having regard to the board’s accountability to shareholders, this is less clear within the proposal to allow voting against. Would mandating a “no” option be accompanied by an obligation on the part of the board to automatically dismiss a director (or accept his or her resignation, thereby eliminating the exceptional circumstances provision) at the pleasure of shareholders? 

If this is the case, it raises two concerns: 

1) That without a proper process or procedure to deal with the consequences of a failed election, (i) there may be an insufficient number of directors elected with the requirements, for example, to have an audit committee comprised of at least three independent directors or, (ii) it would result in the loss of directors with a particular skill set which the board believes is necessary or desirable. 

2) Some short-term securities holders motivated by something other than the long term growth and stability of the organization could view director elections as a means to disrupt the operations of the board and the company. 

If this is not the case, what would be the difference between the proposal and the status quo given that the vast majority of listed issuers already have individual elections and majority voting policies (and those listed on the TSX are mandated to have such)?

The Government should also be mindful that a significant number of shareholders rely on the analysis and recommendations of proxy advisory firms when deciding how to vote their proxies. Proxy advisory firms are unregulated services that have steadily gained significant influence in Canada’s capital markets. 

In the ICD’s comment letter to the Canadian Securities Administrators (CSA) regarding their Proposed National Policy 25-201 we highlighted that, 

“Concerns have been raised about the inexperience of proxy advisory firm staff who are required to analyze complex subject matter. Given the very high volume of vote recommendations prepared every proxy season by advisory firms, the risk for error is great. The impact of error can be even greater. Indeed, we are aware of many circumstances where voting recommendations of proxy advisory firms contained mistakes and inaccuracies.” 

While recent guidance from the CSA indicates that proxy advisory firms should be more transparent about the experience and training of the staff performing analysis, these concerns remain. “No” vote recommendations based on faulty and incomplete analysis would not only be egregious but also potentially disruptive to the conduct of board duties. 

Finally, as the Government is aware, there remain serious concerns about the accuracy of the proxy voting system. While the CSA has initiated a project to improve the system, at present, concerns remain over issues such as over voting and empty voting. We continue to believe that if changes to corporate governance practices are going to put greater emphasis on voting by shareholders, resulting in more potentially contentious business at meetings, then the integrity of the proxy voting system should be addressed before additional pressure is placed on it. 

Unless there is a meaningful difference between voting against a director nomination and voting “withhold” within the context of an individual election and majority voting policy (as is now the practice), we would discourage the Government from pursuing legislative change as this would be duplicative and more difficult to amend in the future. If, however, there is a meaningful difference (e.g. boards would be obligated to accept the resignation of directors receiving majority votes against), we believe the Government should further study the possible implications of mandating “no” voting.

Conclusion 

We encourage the government to immediately adopt the Expert Panel’s recommendation to bring clarity to the director liability and due diligence regimes and would encourage further study of the potential impact of amending the OBCA to eliminate the 25% rule and to allow shareholders to vote “no” against directors. Finally, we encourage the government to consult closely with the province’s business community to align legislative changes with their concerns and needs. 

As a national organization concerned with improving Canada’s economic performance, the ICD supports the Ontario Government’s broader objective to make the province a more business-friendly jurisdiction and thank you for the opportunity to comment.