I. INTRODUCTION2017-03-03T18:33:22+00:00

The Board of Governors approved this project on February 5, 2009 and work commenced in July 2009. The project considers the advisability of applying the principle of joint and several liability to professional advisors to corporations under the Ontario Business Corporations Act (“OBCA”).[1]

 

A.   The Ontario Business Corporations Act

 

In Canada, individuals may incorporate a business under the federal business law statute or one of a number of provincial/territorial statutes. Ontario’s Business Corporations Act contains corporate law rules and duties that govern the relationship between the corporation, directors, officers, its shareholders and its stakeholders. A corporation can be incorporated under the OBCA but its operations may or may not be physically located in  Ontario. Nonetheless, the OBCA will be the governing statute for corporate law matters for those businesses incorporated under it. Some corporate law rules are mandatory while others are default rules that can be opted out of by the parties.

 

Corporations can be classified as private or public. A private corporation, also known as a closely held corporation or a non-offering corporation, has few shareholders, each with a relatively significant economic interest. The shares of closely held corporations generally have restrictions on their transfer of ownership. In contrast, a public corporation, also known as a widely held corporation or an offering corporation, has many shareholders, each of whom has a relatively small economic stake in the corporation. Shares of public corporations are freely-tradeable and often trade on stock exchanges.[2]

 

Certain corporate law rules are mandatory for both private and public companies. Directors of both private and public companies must present the company’s financial statements to the auditors before each annual meeting of shareholders.[3]

                                                                                                        

However, some rules that are mandatory for public companies are simply default rules for private companies and can be opted out of by shareholders. For example, a non-offering OBCA corporation can be exempted from the requirements to appoint an auditor if all of the shareholders consent in writing to such an exemption.[4] The differential treatment of public and private companies recognizes that (i) auditors serve a valuable purpose in verifying a company’s financial statements but that it comes with a significant cost; and that (ii) where the shareholders unanimously decide to forgo an audit because the cost exceeds the benefit, the law should facilitate that outcome. The differing rule also recognizes that it would be extremely difficult, if not impossible, to obtain unanimous consent of shareholders to forgo the appointment of an auditor for most public companies and that benefit of audited financial statements exceeds the costs, particularly in the context of protecting retail investors and maintaining the integrity of the capital markets.

 

Some rules are mandatory for public corporations but not required at all for private corporations. In addition to presenting financial statements to the shareholders, noted above, public corporations must file financial statements as required under the Ontario Securities Act (“OSA”).[5] An offering corporation must also create an audit committee[6] and appoint an auditor to examine the company’s financial statements.[7] Offering corporations also have a duty to solicit proxies[8] and to distribute management information circulars,[9] require at least three directors[10] and are subject to compulsory acquisition rules.[11] Offering corporations have further disclosure requirements under the OSA, as described in this Report.

 

Under the OBCA, directors are responsible for managing and supervising the business affairs of the corporation.[12] They owe a statutory duty of care and fiduciary duty to the corporation: they must act honestly and in good faith with the best interests of the corporation in mind.[13] The fiduciary duty has been interpreted by the courts, including the Supreme Court of Canada, to include duties to consider the interests of a range of stakeholders, including creditors, employees and customers.[14]

 

Directors must also comply with the OBCA, its Regulations, the Articles and bylaws of the corporation and any unanimous shareholder agreements.[15] Directors may also be personally liable under federal or other provincial statutes, such as the Income Tax Act or Employment Standards Act, 2000. While the statutory duties and personal liability of directors are mandatory and cannot be opted out of,[16] a corporation may indemnify a director or officer against costs, charges and expenses in certain circumstances[17] and also purchase insurance for them.[18]

 

Shareholders of an OBCA corporation also have rights against the corporation. They have the right to elect the directors,[19] approve bylaws,[20] formally appoint the auditor[21] and review the corporation’s financial statements.[22] Shareholders also have the right to approve fundamental changes to the corporation, such as amendments to the Articles of Incorporation, statutory amalgamations and sale of all or substantially all the assets of the firm.[23]  A fundamental concept of Canadian corporate law is shareholder limited liability. While directors and officers are personally liable for a breach of their duties, as noted above, a shareholder is not financially responsible for more than his or her investment in the corporation.[24]

 

Shareholders can be classified in different ways. Retail shareholders or retail investors can be defined as individuals who buy and sell shares of companies directly, for their own account. Retail shareholders are presumed to be financially unsophisticated, with limited financial savvy, few financial resources and less incentive to perform extensive due diligence on their holdings because the stakes they hold in public companies are relatively small. These limitations mean that retail investors tend to be less engaged with and have less say in corporate affairs of public companies.  Ontario securities law, which governs public companies, contains numerous provisions designed to protect the retail investor.

 

In contrast to retail investors, institutional investors are large, more sophisticated investors including pension funds, life insurance companies, mutual funds, hedge funds and private equity funds. They may be investing on their own account or for individuals.  Institutional investors tend to have significant and diversified investments, large financial resources, sophistication and financial acumen, and complex ownership and investment strategies. Securities law statutes often contain carve-outs that acknowledge the sophistication of such investors and their ability to better protect themselves.

 

Aside from shareholders, the corporation may contain a diverse array of stakeholders who have an interest in the affairs and well being of the corporation. These stakeholders include creditors, employees and customers. Depending on the nature of the business or characteristic of the individual stakeholder, they may be more or less sophisticated and have more or fewer resources, with corresponding effects on their bargaining power and ability to negotiate contracts, and hence the need for regulation to protect them.  Creditors such as financial institutions will tend to be more sophisticated, with large amounts of resources and bargaining power, while trade creditors could have less of both. Employees are likely on the lower level of sophistication, though they may potentially be backed by more powerful trade unions. Customers in the context of consumer products would likely tend to be on the lower end of sophistication and bargaining power vis-à-vis the corporation, though a customer in a business-to-business transaction may be quite sophisticated and have a significant amount of bargaining power. Hence the need for regulation to protect vulnerable parties would vary depending on the stakeholder and business in question.

 

Corporations, their directors and officers rely on professional advisors to assist in carrying on the business and affairs of the corporation and helping to fulfill the corporation’s regulatory requirements. Auditors are engaged to audit financial statements and prepare audit reports, lawyers advise on the array of legal and regulatory issues, and other professionals, such as engineers, actuaries or geologists, may be used as required by the nature of the company.

 

As a public policy matter, we want to ensure that corporations comply with the law. We use a range of market and non-market mechanisms to attempt to ensure compliance with the law. One market mechanism that is commonly cited as achieving compliance is reputation. A company’s reputation in the market has potential effects on its profitability, giving incentive for a corporation to ensure a good public image; this is fostered by a reputation for compliance with the law. Another market mechanism is proper executive compensation: managers of a company should act in the best interest of the company, and their compensation should be balanced to ensure that their own interests do not unduly influence their corporate decision making.

 

Non-market mechanisms, particularly legal mechanisms, attempt to ensure compliance by creating fiduciary duties on directors and officers, along with the threat of private enforcement by aggrieved stakeholders. In the context of the public company, the active securities regulator provides further incentive to comply with the law.

 

Professional advisors such as auditors, lawyers, engineers and actuaries face similar incentives and pressures. Reputation, for example, operates in the same way for an auditing firm as it does for a corporation. Legal and quasi-legal rules created by professional regulatory bodies contribute to the pressure to comply with professional standards and legal requirements, as does the threat of private litigation.

 

Focusing on private litigation in the context of an OBCA corporation, there are many potential plaintiffs, causes of action and defendants. Plaintiffs can include the corporation, its directors and officers, individual shareholders, creditors, employees and other stakeholders. Causes of action can be found in contract (for example, for a breach of contract) or tort (for example, negligent misrepresentation). Defendants could include the corporation, its directors and officers and, critically, the corporation’s professional advisors. Where there are multiple defendants to one action that are found to be at fault, the principle of joint and several liability currently applies, such that the plaintiff(s) may seek the full amount of the damages from any one of the co-defendants, with such defendant then having an opportunity to seek contribution from the co-defendants. This rule causes particular concern when one of the co-defendants, such as the corporation, becomes insolvent or otherwise unavailable, leaving one or all of the other co-defendants responsible to pay the plaintiff the full amount of the damages. 

 

 

 

 

B.   Purpose of Report

 

The purpose of this report is to analyze whether the provision of joint and several liability that operate for claims relating to OBCA corporations should be reformed to some version of proportionate liability and/or a statutory cap on damages. The focus of this report is specifically with respect to private litigation in the context of OBCA corporations and not about tort reform more broadly. However, analysis of issues arising from the broader context of the liability of joint tortfeasors and tort law and policy contributed to the LCO’s analysis, conclusions and recommendations.

 

The LCO considered the issue of liability reform by reviewing key policies and rationales underlying the tort system, including compensation, deterrence and fairness, and also addressed joint and several liability and alternatives in the broader context of proof of the substantive elements of tort law and professional negligence.

 

The report also considered the key advantages and disadvantages of different forms of liability, including joint and several liability and alternatives including proportionate liability, capped liability and contractual limitations.

 

The LCO received arguments advanced by those in favour of the current system as well as proponents of reform including:

 

rising insurance costs and caps on insurance coverage;
the concern of catastrophic loss, potentially causing the ruin of an auditing firm and exacerbating the current concentration of audit firms;
the deep pockets syndrome; and
rising costs of professional services and losing qualified people from entering the professions.
 

The significant difference between joint and several liability, on the one hand, and proportionate liability or statutory caps on the other hand, concerns the allocation of risk. The former puts the risk of insolvent or unavailable co-defendant on the other co-defendants, while the latter transfers the risk to the plaintiff.

 

Since tort law is a social, economic and political institution, the public policy analysis should center on who should bear the burden of an insolvent, financially limited or unavailable defendant: the plaintiff or the other co-defendants. Relevant questions to be asked include: who is in the best position to bear or distribute the loss, who has the best information about the wrongdoing, and who is able to avoid the loss at least cost?

 

 

C.    The Consultation Process

 

On October 28, 2009, the LCO, supported by the Hennick Centre for Business and Law, held a half-day roundtable discussion to review the joint and several liability scheme for professionals under the OBCA. A short Background Paper had been prepared as background for the Roundtable. Specifically, the LCO sought feedback on whether the current rule of joint and several liability under the OBCA should be modified to bring it into greater alignment with the OSA, the Canada Business Corporations Act (“CBCA”)[25] and trends in other jurisdictions.

 

The Roundtable panelists and participants consisted of a diverse range of professionals who represented the interests of various stakeholders, including corporate lawyers, accountants, litigators (plaintiff-side and defendant-side) and consultants. The Roundtable began with an overview of the amendments to and experience with the CBCA and the OSA and generated discussion on various industry perspectives.

 

The views expressed in the roundtable were taken into account in preparing the Consultation Paper released in May 2010.[26] The Consultation Paper was posted on the LCO website and distributed widely, including to the Roundtable participants. The Consultation Paper provided background, asked 16 specific questions, outlined options for reform and asked for feedback. Comments were encouraged until June 30, 2010, but were also accepted beyond this date. The LCO received a total of 17 submissions from various stakeholders, ranging from those adamantly opposing reform to those stressing an urgent need to move toward a proportionate liability regime. (See Appendix B for a list of individuals and organizations who participated in the Roundtable and/or made submissions.)

 

On the whole, submissions from the legal community, including the Ontario Bar Association (OBA) and the Ontario Trial Lawyers Association (OTLA), favour the status quo. In contrast, members of the auditing profession and other professional groups, including the Institute of Chartered Accountants of Ontario (ICAO) and the Canadian Public Accountability Board (CPAB), stress the need to reform the current joint and several liability regime which they claim, among other effects, threatens the future of the auditing profession.

 

The submissions informed the analysis, conclusions and recommendation to retain the application of joint and several liability under the OBCA in the LCO’s Final Report.

 

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