DCC 45 v Swan: Drawing Key Distinctions between the Duties of Loyalty and Care

Durham Condominium Corporation No. 45 v  Leslie Arthur Swan, 2015 ONCA 590 [Swan] is a brief case that raises key issues around board members’ statutory and contractual entitlements to be indemnified for legal liability and costs personally incurred in the course of duty. However, the issue that stands at the forefront of this case concerns the resulting distinction that courts must necessarily make between breaching the duty of care versus the duty of loyalty to the corporation.

Under federal and provincial incorporation statutes, board members, who are personally sued for discharging their directorial duties below the standard of care, are typically entitled to have the Board defend the actions on their behalf and to be indemnified for costs incurred against them.

Similarly, s, 37(1) of the Condominium Act, 1998, SO 1998 c. 19 [Condo Act] creates parallel duties for directors of condominium boards and a similar statutory entitlement permitting directors, if the corporation’s by-laws so specify, to claim indemnity for liability and legal costs.

Under the provisions of such statutes, board members are disentitled to indemnity if their liability or cost-incurring conduct amounts to fraud, dishonesty or bad faith conduct, as these breach the duty of loyalty to the corporation.

As the Ontario Court of Appeal aptly points out in Swan, the applications judge, in determining the Appellant was not entitled to be indemnified because of his dysfunctional conduct while in office, conflated a breach in the duty of care with a breach in the duty of loyalty and wrongly decided this portion of the case.

However, in ordering that the case be returned to the applications judge to decide, amongst other things, what type of breach the Appellant’s conduct amounts to, the Ontario Court of Appeal failed to provide much needed guidance on how the lower courts should distinguish between the two. With readily available corporate law jurisprudence that has covered significant ground in this regard, the court could have drawn on the broader principles therein to more fully elaborate on the appropriate approach.

Facts

The Appellant, Leslie Arthur Swan, was Director and President of Durham Condominium Corporation No. 45 (“DCC 45”). A self-stylized whistle-blower, Mr. Swan was on a crusade to hold the other board members accountable for what he alleged was improper conduct.

Amongst his complaints was that the Board lacked authority to contract out the Secretary’s record-keeping function to a third party company, MCD. He also questioned on several occasions whether other board members were properly performing their duties and demanded that MCD return the corporate records. While Mr. Swan seemed genuinely concerned about the Board’s governance, the other board members considered his demeanour to be “insulting threatening and confrontational.”

As Mr. Swan’s conduct continued, a board member circulated a requisition, under s. 46 of the   to call a meeting of the unit owners to vote on removing Mr. Swan as a director of the Corporation. Mr. Swan subsequently launched a claim in Small Claims Court for defamation against the Board, which he personally served, as Plaintiff, upon himself as representative of the Board. He followed by attempting to terminate MCD’s management contract without a resolution of the directors. MCD and the Board disregarded the termination notice and carried on.

Mr. Swan further commenced two claims against the principle of MCD, one for defamation and the other for conversion, naming DCC 45 as Plaintiff for both. These were later discontinued. After Mr. Swan was officially removed as a director on September 17, 2009, he personally launched claims against two of the directors.

DCC 45 subsequently brought an application for a declaration pursuant to s. 134 of the Condo Act, requesting that Mr. Swan be found in breach of his duty to act honestly and in good faith, under s. 37(1)(a) and to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances under s. 37(1)(b) of the same statute. Mr. Swan in turn brought a cross-application seeking a declaration for, amongst other things, his reinstatement as a director on the Board.

The applications judge found that Mr. Swan rendered the Board divisive and dysfunctional through his conduct, including the claims he brought against and on behalf of the corporation, misleading the Board by accepting service of his own claim on behalf of the Board and sending harassing and confrontational emails to other Board members. On this basis, the applications judge found that Mr. Swan failed to exercise the requisite duty of care under s. 37(1)(b).

Interestingly, the applications judge did not comment on whether Mr. Swan acted disloyally or in bad faith towards the corporation, but merely stated that for a director to fully comply with s. 37(1)(a) of the Condo Act, he was required to do more than act honestly and in good faith. He was required to exercise the “care diligence and skill that a reasonably prudent person would exercise in comparable circumstances” pursuant to 37(1)(b). Thus, the applications judge in effect held that for a director to comply with the first requirement, he must necessarily comply with the second and as a result, Mr. Swan failed to comply with the entire provision. A cost order of $45,000.00 against Mr. Swan followed.

The issue on appeal was whether Mr. Swan, as a director, was entitled to indemnity for legal costs. The Court relied on s. 38(1) of the Condo Act which permits a corporation to indemnify its directors against liability and legal costs arising from a director’s actions or omissions while executing his duties of office. DCC 45 had a by-law in place stating that it shall indemnify its directors against the costs of a legal action (para 10).

The Court further relied on s. 38(2) of the Condo Act, which prohibits the indemnification of a director for liability and legal costs “as a result of which the person is adjudged to be in breach of the duty to act honestly and in good faith.” It ultimately found, in two lines of analysis, that the applications judge erred by conflating the duty of care in s. 37(1)(b) with the duty of loyalty in 37(1)(a) but refrained to elaborate how the provisions should be properly applied. In returning the action to the lower court to determine this very issue, the Court of Appeal failed to provide necessary guidance for future cases involving s. 37(1).

Possible Guidance on Assessing Breaches of Directors’ Duties

Significant ground has been covered by Canadian jurisprudence with respect to the liability of corporate directors for breaching the duties of loyalty and care. It is important to note that s. 122(1) of the Canada Business Corporations Act, RSC, 1985, c C-44 [CBCA] contains an almost identical two-part provision where under 122(1)(a) directors have a duty of loyalty to the corporation, and, under 122(1)(b), must exercise care, diligence and skill. The applications judge’s reasoning in Swan that breaching the duty of care necessarily amounts to a breach in the duty of loyalty to the corporation is inconsistent with Supreme Court jurisprudence pertaining to the duties of corporate directors.

The duties of loyalty and care are distinct concepts. While a breach in the duty of loyalty amounts to a breach in the duty of care, the opposite is not true. For a director to be in breach of his duty of loyalty, a separate finding is required. According to BCE Inc. v 1976 Debentureholders, [2008] 3 SCR 560, the duty of loyalty is owed exclusively to the corporation. Accordingly, the duty of loyalty entails, at minimum, compliance with statutory obligations on the basis that non-compliance is prima facie not in the corporation’s best interests.

The duty of loyalty serves the function of preventing directors from appropriating the corporation’s wealth, usurping corporate opportunities and taking actions using corporate resources, to achieve a personal agenda. Acting in a manner that places the corporation’s economic viability at risk and causes a decline in its value does not by itself constitute a breach in the duty of loyalty. A finding of bad faith conduct or fraud is required, however, the standard of proof is onerous. As long as a director can show he was acting in pursuit of a bona fide corporate purpose, courts will defer to their business judgment, however wrong in hindsight.

The duty of directors to exercise care, diligence and skill when performing their administrative function is owed to the corporation. According to Peoples Department Stores Inc. (Trustee of) v Wise, [2004] 3 SCR 461 the duty under 122(1)(b) of the CBCA requires directors to be reasonably informed on how their decision-making affects the corporation. The duty of care safeguards, not against shirking or failed decisions, but against a director’s derelict abdication of his duties and ignorance to the requirements of managing the corporation.

Interestingly, Mr. Swan’s conduct in many respects appears to be self-serving. The launching of the claim in the corporation’s name without the Board’s knowledge and Mr. Swan’s receipt of his own claim against the Corporation on behalf of the Board creates a conflict of interest. On the one hand, Mr. Swan was motivated by a desire to ensure better management of the corporation. However, on the other hand, he brought an action against the corporation as a whole for defamation and then proceeded to use the corporation to launch actions against two of its directors. He arguably should have stepped down as a director of the corporation he was in conflict with. However, this was not the applications judge’s basis for finding him in breach but instead his dysfunctional behavior on the Board.

Conclusion

How this case will be decided remains to be seen. However, the Court of Appeal should have undertaken a thorough analysis of directors’ statutory duties. While there is no reason why corporate law jurisprudence cannot be relied upon, if the context around directors’ duties in the Condo Act is that much different, it makes the need for guidance that much more pressing.