directors liability

The wind is howling this morning after a night of pelting rain.  I woke up to find the Dow trading below 7,000 - the first time it has been that low since 1997.  It’s surreal that the Dow has lost over half its value in the last sixteen months after trading at an all time high of over 14,000 in October 2007.

I am very thankful that the majority of the companies in the Business Ready portfolio are weathering this recession but lately I find myself giving a lot of advice regarding directors liability.

If you are an avid reader of this blog you know we strongly believe CASH is everything.  You should enter every meeting and engagement being able to answer two questions:

how much cash do you have on hand? what is your cash zero date?

However, a third question has started to sneak into conversations:

can you cover your directors liability?

Huh? What? What is directors liability?  When a company goes bankrupt and there is a shortfall to creditors, the directors in most cases are not personally liable for any shortfall.  HOWEVER, the directors ARE liable if they have (a) given personal guarantees for debt or (b) if laws have been passed specifying that directors are liable to certain creditors (e.g. “statutory creditors”).  In most provinces in Canada statutory creditors include the government and employees and this is what makes up your personal liability as a director.  In particular, you should be aware, at any given time, of:

1. outstanding wages to employees: you are responsible for wages owed (including accrued vacation) and in some provinces the statutory requirement of severance;
2. outstanding source deductions: you are responsible for all unpaid source deductions and any interest or penalties that are owing;
3. GST and PST outstanding.

Of course, you should seek legal counsel to determine the precise scope of statutory liability affecting you but the above three points are a good back of the envelope.  The sum of these three items is the liability.  You should have enough CASH (not receivables, etc.) to cover this liability.  When you drop below this it is your responsibility to inform your directors that you do NOT have enough cash to cover the directors liability so that they may discuss the best course of action.

So, what happens if you are a board member of a company that is unable to cover its directors liability?  While that is a personal judgment call for you whether you remain a board member or not I would like to remind you:

• directors can be personally liable;
• ignorance is not a defense;
• resignation is not necessarily a defense (e.g. if the liability was incurred while you were a director you are still responsible);
• board indemnity may not be enough so please review your indemnity agreement;
• directors may be responsible for non-performance;
• review your directors and officers insurance to see what your policy covers;
• seek advice from your legal counsel.

If you want further help, the Canadian Institute of Chartered Accountants put out a publication: 20 Questions Directors Should Ask about Directors’ and Officers’ Liability Indemnification and Insurance.  You may want to give it a read.

When will this storm break?