Shareholder primacy has been a widely accepted norm in the business community for decades, leading executives and directors to focus on maximizing profits along with the value of the corporation’s shares. Nevertheless, critics have long questioned whether public companies should prioritize the interests of investors over the interests of other stakeholders, noting the concept of shareholder primacy did not always serve as the guiding light for corporate governance. The debate over shareholder primacy resurfaced with a vengeance amid the COVID-19 pandemic. Calls for corporate governance reform tend to appear during periods of major societal and economic upheaval, so they are nothing new. However, the current debate over corporate governance is complicated by the lack of clarity imbued within the law and regulations currently governing the fiduciary duty of Canadian corporate directors—which have been heavily influenced by the shareholder primacy norm.

The most recent analysis of the legal standard that dictates the fiduciary duty of directors in Canadian corporate law was issued in December 2008 when the Supreme Court of Canada (SCC) released the ground-breaking BCE v 1976 Debentureholders decision. Some scholars theorized that this decision signalled a shift toward a more stakeholder-friendly model of corporate governance by calling on directors to act in the “best interests of the corporation.” However, there was dissention surrounding the practical meaning of the BCE decision. And amid today’s calls for governance reform, this creates a significant dilemma for corporate boards.

This paper provides an overview of the framework governing the fiduciary duty of directors with an analysis of the historical and economic context that has underpinned this area of corporate law since the Great Depression. Using guidance from leading corporate governance practitioners and institutions, we then examine what director duties within Canada might look like in the future while offering insights from the landmark BCE decision to help manage the director’s dilemma.

The Corporation, Directors, and Canadian Law

According to corporate law scholar Christopher Nicholls, the five defining characteristics of a corporation are: 1) separate legal entity; 2) limited liability; 3) transferable shares; 4) perpetual existence; and 5) centralized management. The delineation between ownership and management allows for the potential for equity financing and empowers shareholders to separate their personal assets so they are not available to the corporation’s creditors. Often characterized as the Salomon principle, this legal structure ensures that the owners or shareholders of the corporation do not lose more capital than they invested.

The board of directors is an integral decision-making body within a corporation that is bestowed with the authority to manage the corporation’s business and affairs. This body can delegate most, but not all, of their duties to an executive team that executes the day-to-day operations of the corporation. While boards are normally concerned with higher-level governance matters, this does not preclude their involvement in managerial affairs when the situation arises. Some activities typically conducted by the board include selecting and monitoring the chief executive officer, deciding upon major transactions and changes in control, overseeing corporate strategy and ensuring the corporation complies with legal and ethical standards.

To fulfill their legal fiduciary duty as defined by the Canadian Business Corporations Act (CBCA), Canadian directors must make decisions based upon what is in the “best interest” of the corporation they serve. This requires a clear understanding of corporate purpose. Unfortunately, when assessing the purpose of the corporation, there are generally two diverging schools of thought. The first describes the corporation as a fictional body designed to facilitate a private agreement between shareholders, thereby treating the interests of these constituents as paramount. The alternative view suggests that the corporation is a “real entity” created to serve society, which means that the needs of various stakeholders must be balanced alongside the interests of shareholders.

These two diverging schools of thought are why it is important that every corporation periodically identifies, discloses, and reviews the definition of corporate purpose that serves as its “guiding light” for directors and members of the management team.

Canadian law is informed by a combination of statutory legislation and the common law, which is developed through judicial court systems. As lawyers Chat Ortved and Rachelle Wong note in an overview of board responsibilities, Canadian corporate governance requirements are derived from three principal sources: 1) corporate legislation and the common law, 2) securities legislation and rules and policies of provincial securities regulators, and 3) stock exchange rules.

Corporations based in Canada can either choose to incorporate via provincial corporate law statutes such as the Ontario Business Corporations Act or federal statutes such as the CBCA. Before determining applicable laws governing a corporate law matter, one should determine the jurisdiction where the company is incorporated.

Generally, directors are protected from personal liability owing to the existence of the “corporate veil” that treats the corporation as a separate legal entity and holds the corporation liable for debts owed, as opposed to its managers or directors. However, this protective veil may be lifted in certain circumstances, and therefore, personal director liability may be incurred if a director breaches either of their two overarching duties: the duty of care or fiduciary duty. The duty of care refers to whether the director conducted due diligence in exercising business judgment for company-related decisions. A director’s fiduciary duty is mandated by a legal standard of expected behaviour of directors in company dealings, requiring that corporate directors put the interests of the corporation before their own.

According to language within the CBCA, the fiduciary duty for Canadian corporate directors can be summarized as a requirement to act “honestly and in good faith with a view to the best interests of the corporation.” Historically, this was understood as being nearly synonymous with the best interests of the shareholder. But when Bill C-97 received Royal Assent in June 2019, the CBCA was amended to specify that directors may, in considering the best interests of the corporation, consider the interests of key stakeholders aside from shareholders, as described below:

122(1.1) When acting with a view to the best interests of the corporation under paragraph (1)(a), the directors and officers of the corporation may consider, but are not limited to, the following factors:

(a) the interests of

(i) shareholders,

(ii) employees,

(iii) retirees and pensioners,

(iv) creditors,

(v) consumers, and

(vi) governments;

(b) the environment; and

(c) the long-term interests of the corporation.

Some scholars theorize that this amendment signalled a greater shift in the economic theories underlying this area of Canadian corporate law. But notably, it did not specify that corporate directors were required to consider the interests of these stakeholders.

Shareholder Primacy

In 1776, Scottish moral philosopher Adam Smith became the father of capitalism with the publication of The Wealth of Nations, in which he argued that individual acts of self-interest in the marketplace will be moved by the “invisible hand” to efficiently serve the best interests of society without the need for government intervention, as long as business owners are solely entitled to all the fruits of their property, meaning the profits.

Smith arguably laid the groundwork for the shareholder primacy model of corporate governance. But The Wealth of Nations was published as the Industrial Revolution was just getting started, and Smith was referencing the impact of self-interest at owner-run businesses, not manager-run corporations, which he considered inefficient. To apply Smith’s views on self-interest to manager-led firms, neoclassical economists eventually substituted Smith’s owner-entrepreneurs with shareholders. But it took time before shareholder primacy became a governance norm.

Early in the twentieth century, the emerging management class faced few constraints on their decision making, which concerned Adolf Berle, a Wall Street lawyer turned academic. In The Modern Corporation and Private Property, published in 1932 with coauthor Gardiner Means, Berle used property rights to argue shareholders, not managers, “ought to receive the profits of the corporation because they acquired ownership of the corporate venture and are the rightful benefactors of all corporate economic surplus to the exclusion of non-owners.”

A year earlier, Berle had initiated one of the most prominent intellectual debates in the history of corporate law by publishing a law review article entitled “Corporate Powers as Powers in Trust,” in which he argued that all powers granted to a corporation or to the management of a corporation “are necessarily and at all times exercisable only for the ratable benefit of all the shareholders as their interest appears.” In response, Harvard law professor E. Merrick Dodd published “For Whom Are Corporate Managers Trustees?”—in which he insisted that it was “undesirable, even with the laudable purpose of giving stockholders much-needed protection against self-seeking managers, to give increased emphasis at the present time to the view that business corporations exist for the sole purpose of making profits for their stockholders.”

At the time, the shareholder primacy model appeared to have been supported by an earlier US court ruling over a dispute between two investors—John and Horace Dodge—and the Ford Motor Company. As minority shareholders, the Dodge Brothers had launched a legal action against Ford after the company suspended special dividends, aiming to redirect resources toward increasing wages and lowering product prices. As Judd Sneirson points out in The History of Shareholder Primacy, Henry Ford made the mistake of testifying at trial that he believed the company made too much money. This allowed the Dodge brothers to argue that Ford’s actions perverted the corporation’s purpose. The court agreed, ordering the automaker to declare a special dividend while deferring to Ford’s business judgment in other areas.

Since Berle’s debate with Dodd followed this court ruling, Berle is often credited with being the grandfather of shareholder primacy, while Dodd is seen as an early advocate of stakeholder capitalism. But their arguments are often taken out of context. Berle argued against the corporate consideration of other stakeholder interests because he worried that directors who were accountable to everyone would justify self-serving business decisions by claiming they were appealing to another stakeholder group. In other words, he saw a need to protect both society and the investors of his day—which included a sizable proportion of the general public—from the management class by limiting their discretion via a strict but narrow fiduciary obligation focused on shareholders.

Over the years, some scholars have argued Berle was actually a supporter of stakeholder theory. Either way, the shareholder primacy mantra was picked up by others who not only argued that generating profits for shareholders should be the primary duty of management, but that this duty also involved maximizing shareholder returns.

During the 1960s, economist Milton Friedman emerged as a proponent of a neo-classical stream of economics premised upon assumptions of supply and demand. Unlike Keynesian economists of the day, he advocated for minimal government intervention and free market capitalism. Amongst other things, Friedman argued that sustainability investments increased a firm’s costs and created a competitive disadvantage in the market. His influence gained traction after his publication of Capitalism and Freedom—which questioned the viability of corporate social responsibility in free-market economies. In such an economy, he wrote, “there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud.”

Inherent within Friedman’s views was his assumption that corporate social responsibility objectives and shareholder primacy could not co-exist because profit maximization conflicted with using corporate resources to serve the interests of other stakeholders. His book preceded a particularly tepid time for the stock market. From 1966 to 1976, there was an overall decline in share prices, which was reflected in the Dow Jones Industrial Average falling from 969 at the end of 1966 to 859 in 1976. This was largely attributed to failures of corporate management, which set the stage for Friedman’s ground-breaking 1970 article “The Social Responsibility of Business Is to Increase Its Profits,” which argued that managers are stewards of shareholders’ wealth and should not use it for “general social interest.”

Supporters of the shareholder primacy model credit Friedman’s theories—which were a standard part of business school curriculums for decades—with laying the foundation for unprecedented economic growth. But critics insist the corporate governance model that Friedman popularized is unsustainable and a threat to economic stability, arguing corporate self-interest played a key role in creating the 2008 global financial crisis while remaining an ongoing major driver of climate change.

The Modern Landscape of Fiduciary Duty

In the decades following the publication of Friedman’s seminal essay, Canadian courts generally agreed with the business community and largely accepted the notion that the best interests of a corporation aligned with the best interests of shareholders. But, while Friedman’s theories and assumptions continue to influence corporate law to this day, two influential decisions by the SCC—one in 2004 and the other in 2008—seemed to challenge the underlying notions that support the shareholder primacy governance model.

In February 2007, the Ontario Teacher’s Pension Plan proposed a transaction to privatize Bell Canada Enterprises (BCE) through a leveraged buyout financed with debt. Investors stood to profit from the transaction, which received the support of 98 per cent of the company’s shareholders. But bondholders faced losses and opposed the deal because its structure threatened to push the credit ratings of BCE bonds to “below investment grade.” Despite the position of BCE creditors, the Quebec Superior Court (QSC) approved the deal as “fair and reasonable” after making a contextual analysis of fiduciary duty. Since BCE was “in play” as an acquisition target, the QSC reasoned that the fiduciary duty of the board was to act in the best interests of the company’s shareholders.

The QSC conclusion seemed to align with prior jurisprudence that reflected a shareholder primacy view. It also mirrored the reasoning employed by US courts in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. In 1986, the Delaware Supreme Court made a landmark decision on hostile takeovers when it declared that directors of a company facing a takeover must follow a narrow definition of fiduciary obligation that requires them to maximize stockholder value by securing the highest price available.

BCE’s bondholders appealed, and the decision was overturned by the Quebec Court of Appeal (QCA)—which determined the process used by the board when executing its fiduciary duty was flawed because it failed to consider the impact on BCE’s bondholders. The QCA decision—which seemed to endorse stakeholder theory—was then appealed to the SCC, which ultimately approved the transaction as fair and reasonable. However, while the SCC came to the same conclusion as the QSC, Canada’s top court disagreed with the QSC’s reasoning. In particular, the SCC rejected the idea that directors had a “Revlon duty” to put shareholders above other stakeholders when negotiating a merger or acquisition.

The SCC ruling stated: “People sometimes speak in terms of directors owing a duty to both the corporation and to stakeholders. Usually this is harmless, since the reasonable expectations of the stakeholder in a particular outcome often coincide with what is in the best interests of the corporation. However, cases (such as these appeals) may arise where these interests do not coincide. In such cases, it is important to be clear that the directors owe their duty to the corporation, not to stakeholders, and that the reasonable expectation of stakeholders is simply that the directors act in the best interests of the corporation.”

According to some legal commentators, the BCE decision represented an ongoing shift in modern jurisprudence away from shareholder primacy since it followed another landmark case in which the SCC found directors owed a duty to the corporation.

In 2004, the trustee representing creditors of Peoples Department Stores brought an action against the company’s managing owners, claiming they had breached their fiduciary duty and duty of care as board members by transferring assets to a parent company while facing bankruptcy. At trial, the QSC ruled in favour of the trustee after concluding the fiduciary duty of directors extends to creditors when a company is approaching insolvency. Upon appeal, the QCA reversed the decision, and this reversal was unanimously upheld by the SCC, which also found that the directors did not owe a duty to the creditors and had acted in the best interests of the corporation by trying to avoid bankruptcy.

While the BCE decision is widely regarded as the most significant development in modern Canadian jurisprudence regarding the fiduciary duty of corporate directors, critics insist it raised more questions than it answered. The lack of clarity can be partially attributed to the principles-based approach in Canadian corporate law, which differs from the more rules-based approach adopted by US courts. The Canadian approach empowers directors to use their judgement and consider a wide array of interests when making business-related decisions, but it becomes problematic when directors are tasked with weighing conflicting interests between different stakeholders.

By giving deference to the board’s business judgment, the SCC seemed to signify corporate directors can favour certain stakeholder interests if their decisions can be plausibly justified as being in the interests of the corporation while meeting a minimum standard of fairness in relation to all stakeholders. This flexibility arguably empowered directors to more easily make decisions that defy shareholder pressure to make corporate decisions that enhance short-term profits while sacrificing long-term economic benefits. But it also arguably waters down the managerial discipline imposed by legal accountability to shareholders.

Simply put, since the BCE decision didn’t explicitly endorse either shareholder primacy or stakeholder theory, the SCC appeared to open the door to a third model of governance with a duty to look out for the best long-term interests of the corporation. Some critics insist this extended the fiduciary duty of directors to a wider range of stakeholders—including employees, creditors, and governments. Either way, the BCE decision—which was released shortly after the onset of the Great Recession—made it difficult for directors to determine how to fulfill their fiduciary duty, since the court failed to provide sufficient guidance to determine how to act when conflicts of interest arise.

Extensive empirical research reveals progress towards a new conception of the “best interests of a corporation” stalled in the years following the BCE decision, when directors appear to have been hesitant to act in ways that defy precedents endorsing shareholder primacy. In fact, amid the lack of clarity, corporate directors appear to have maintained a persistent attachment to the shareholder primacy model along with a definition of corporate purpose that supports the maximization of short-term value for shareholders. Furthermore, jurisprudence and corporate law disputes following the BCE decision seemed to acknowledge that certain economic theories (namely that business is primarily for wealth maximization and that rational choice theory can predict market behaviour) linger in the economic analysis of law.

In June 2019, the CBCA amendment came into effect, specifying “directors and officers may consider, but are not limited to considering, the interests of creditors, consumers, governments, employees and pensioners, the environment and the long-term interests of the corporation.” This amendment has yet to be adopted by any provincial corporate law statutes and may only apply to directors of corporations incorporated under the CBCA. Furthermore, only CBCA provisions pertaining to director duties were interpreted in the BCE decision. Therefore, it is unclear whether the guidance provided on the director’s fiduciary duty would apply to corporations governed by provincial corporate law regimes.

Nevertheless, until another case clarifies the SCC’s position, BCE and the CBCA amendment that followed constitute the leading guidance on the matter for corporations governed by the CBCA. And while some scholars theorize that it signalled a greater shift in the economic theories underlying this area of Canadian corporate law, others insist it merely codified the law as previously set out in the BCE decision and did not substantially alter existing director duties as per the CBCA.

As a result, while a growing body of literature suggests that what counts as the best interests of a corporation and good business judgement is changing in courts of law and public opinion alike, the official definition of a director’s fiduciary duty arguably remains an indeterminate area of corporate law.

Corporate Purpose in the Age of COVID-19

The modern era—characterized by rising inequality, systemic racism, and climate change—has amplified the public perception that corporations should play an enhanced role in rectifying economic and social issues. But corporate directors don’t necessarily agree with this sentiment. According to a 2020 survey of Canadian board members conducted by the Institute of Corporate Directors, only 31 per cent strongly agreed and 48 per cent somewhat agreed that their organizations should actively engage in rectifying social inequalities. And only 54 per cent strongly agreed that the board is ultimately responsible for the societal impact of their organization, positive or negative.

Since shareholders are ultimately responsible for electing board members, corporate directors are incentivized to ensure that the interests of shareholders are prioritized. But it is important to note that there are also operational barriers to implementing the emerging stakeholder model of corporate governance, which have cost implications.

Despite the challenges, corporate boards are being warned to expect new standards for dealing with stakeholders, especially on environmental, social and governance (ESG) related issues.

And with nearly a third of global assets under management already required to meet certain standards pertaining to ESG, public companies were feeling extensive pressure to reject shareholder primacy even before the pandemic. This pressure resulted in what was initially widely seen as a revolutionary change in US corporate thinking.

In August 2019, America’s Business Roundtable (BRT), a prestigious association comprised of chief executive officers from industry-leading companies, appeared to endorse the evolution to stakeholder theory by updating its official definition of corporate purpose. Spearheaded by the CEO and chair of JPMorgan Chase, BRT signatories committed to making business decisions that served the interests of multiple stakeholders in a statement that mentioned customers, employees, suppliers, and communities before the objective of long-term value for shareholders was even acknowledged. However, while the BRT statement made headlines and increased public expectations for change, it wasn’t endorsed by the directors of BRT member companies and appears to have had no significant impact on how they serve as directors. This has generated skepticism over whether shifting public perceptions on corporate governance will result in meaningful changes to the way business is conducted.

Nevertheless, on the global stage, the World Economic Forum—which advocates for a new understanding of corporate purpose that aims to produce profitable solutions that solve the problems of the people and the planet—has cautioned against directors concentrating on short-term profits and objectives at the expense of long-term economic prosperity. In Great Britain, the UK Institute of Directors has called for a new conception of a company’s purpose, public service corporations, and a corporate governance commission. And state-level corporate law in the United States reflects a shift towards stakeholder theory. In the execution of their fiduciary duty, corporate directors in over thirty US states can now consider the interests of other constituents such as employees, retirees, creditors, and communities.

Clearly, a further evolution in corporate governance appears on the horizon, and the COVID-19 pandemic may act as a catalyst for greater clarification on the fiduciary duty of a director in Canada, where many commentators insist a new model for corporate governance built upon the analysis provided in the BCE decision is warranted.

Alternative Organizational Structures

Although various institutions and governance experts seem to have embraced the perceived shift towards stakeholder theory, the practicality of this governance model in the for-profit world remains open to question, especially amid the legal ambiguity that appears to impede public companies from moving beyond shareholder primacy.

Meanwhile, as corporate governance scholar Frankie Young points out, non-profit corporations can prioritize social mandates, but are limited in their ability to support society via the creation of government revenue since they are generally exempt from corporate taxes pursuant to section 149(1)(l) of the Income Tax Act. The non-profit sector also typically finds it more difficult to raise capital since it isn’t focused on wealth creation. Unlike public companies, non-profits have “members,” not shareholders who receive dividends.

In recent years, the line between the for-profit and non-profit worlds has blurred thanks to an emerging business model that aims to produce profits while addressing social problems. A so-called “social enterprise” can raise capital through equity financing, but unlike traditional public companies, it does not exist to maximize shareholder returns. Instead, community objectives are procedurally and structurally embedded in the firm’s governance model. In the cosmetics industry, for example, Cheekbone Beauty has adopted a purpose-driven business model that allows the company to allocate 10 per cent of its profits towards Indigenous education.

Although the term “social enterprise” is not explicitly found within Canadian corporate statutes, similar forms of asset management can be found in two provincial corporate law jurisdictions: British Columbia and Nova Scotia. These provincial statutes specify that the notice of articles for these entities must specify their community purpose. There are also restrictions surrounding the types of activities that social enterprises can pursue as well as the portion of profits that may be distributed and to whom. However, the need for legal recognition of these entities has been questioned since the SCC has ruled that directors may consider various objectives in assessing the overall “best interests of the corporation.” In other words, the modern legal conception of fiduciary duty in Canada arguably may empower corporate board members to make decisions that prioritize community commitments over a corporation’s shareholder interests, if it is deemed to be in the best interests of the corporation. Therefore, the objective of a social enterprise could be accomplished by forming a corporation, which may make social enterprises redundant as an alternative organizational structure.

Navigating the Director’s Dilemma

When the SCC opened the door for directors to consider other stakeholder interests, it failed to sufficiently address how corporate directors should deal with conflicts of interests between stakeholders and did not account for the economic realities of corporate governance. As a result, despite public calls to infuse stakeholder theory into Canada’s corporate governance framework, there have not been significant changes to corporate governance structures since the release of the BCE decision, and the notion of shareholder primacy still lingers in the decision-making process for corporate boardrooms.

What the future framework for corporate governance in Canada will look like is currently a matter of speculation. Various marketplace participants—ranging from directors, corporate lawyers and academics to stock exchanges, institutional investors and proxy advisory firms—have their own perspectives on how corporate governance should evolve. However, opinion is divided. Some support reforms that would force businesses to meet the growing demand for expanded corporate purpose, but others insist shareholder primacy is the only workable model.

Simply put, until something official changes via a new SCC decision or updated corporate legislation, Canada will remain without a clear legal definition of fiduciary duty. As result, the court’s previous deviation from the shareholder primacy approach in Peoples and BCE will continue to present complications.

That’s the director’s dilemma, which will exist until gaps in Canadian corporate law are addressed. In the meantime, Canadian boards should prepare for anticipated legal changes by engaging with a broad range of stakeholders while remaining open to change and heeding the following insights from the BCE decision. When competing interests arise, the overriding principle for corporate directors should be to act in the best interests of the corporation by making decisions that aim to drive long-term success, as opposed to immediate profits and increased share value. Finally, while not all stakeholder interests must be considered in every execution of a director’s fiduciary duty, individual stakeholders must be treated fairly and equitably.

 

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