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Case underlines importance of indemnification rights

A recent Ontario Court of Appeal decision highlights how vital it is that directors and officers ensure that a corporation's bylaws and indemnification contracts protect them to the fullest extent permitted by law, says Toronto civil litigator Patricia Virc.

"It happened to work out well for the director in this particular case because she had the indemnification that is permitted by statute – it was actually part of her contract with the entity," says Virc, a lawyer with Steinberg Title Hope & Israel LLP.

"However, directors have to be careful," she tells AdvocateDaily.com. "They need to make sure that they are secure that the indemnification is actually either part of the bylaws of the corporation or in contract with the corporation otherwise they may have no practical recourse to indemnification."

The case, Legg v. Simcoe Muskoka Catholic District School Board, 2014 ONCA 745 (CanLII), involves Diane Legg, who was employed by the school board as a director. In February 2014, as the result of complaints made by fellow employees, Legg was suspended from her position on suspicion that she may have submitted fraudulent expense claims. She was suspended with pay pending the results of a third-party investigation. Following the investigation, Legg’s employment was terminated.

Legg brought an application before the Superior Court of Justice in April seeking payment of her ongoing legal expenses pursuant to a provision in her employment contract. The school board unsuccessfully argued that Legg was not entitled to indemnity because the indemnity clause did not apply to workplace investigations and that Legg failed to act honestly, which invoked an exclusion of her contract.

In dismissing the school board's appeal, Court of Appeal Justice Jean L. MacFarland affirmed that the law presumes that persons act honestly until the contrary is proved, citing Blair v. Consolidated Enfield Corp., [1995] 4 SCR 5, 1995 CanLII 76 (SCC).

Virc, who successfully argued for the respondent in 1995's Blair, says the decision in Legg "reaffirms the fact that once you have that indemnification right secured pursuant to either contract or bylaw, it is not up to the director or officer to prove at the very outset that they've acted in good faith, and therefore they are entitled to that indemnification right," she says.

"The director might ultimately be found not to have acted in good faith, but that's not enough. The director is presumed to have acted in good faith at the threshold point at the beginning," she says. "It's very important from a procedural perspective in order for the director to have the resources that he or she needs to manage the litigation."

She notes that indemnification under statute – the Ontario Business Corporations Act or the Canada Business Corporations Act – is discretionary in many cases and mandatory in only limited cases.

"The Business Corporations Act allows corporations to extend directors’ rights to indemnification and to buy D & O insurance, but it is up to the company to make it mandatory," Virc says. "Indemnification can be made mandatory if written into a contract (as it was in the Legg) or written into the company’s bylaws (as it was in Blair).

"In order for the mandatory indemnity provisions to extend to all officers and directors, the corporation could amend its bylaws," she says. "Such an amendment must be confirmed by the shareholders at the next annual meeting."

However, a director has to remember that the bylaws can be changed by resolution of the board, Virc says.

"If you have a falling out with your board and it decides to change the bylaws, then you might have a problem," she says. "The way to really secure an absolute right would be to put it into a contract and ensure that the company has D & O insurance for its directors and officers, that way if something happens a third-party insurer can fund the litigation costs."

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