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Ontario Court of Appeal Clarifies Directors’ Entitlement to Indemnification Under CBCA

The Ontario Court of Appeal’s recent decisionin Bennett v. Bennett Environmental Inc. has clarified the entitlement of a director to indemnification from a corporation under the Canada Business Corporations Act (CBCA).

Bennett Environmental Inc. (BEI) is a publicly traded company that provides high temperature treatment services for the treatment of contaminated soil. John Bennett served on the board of directors of BEI and was a member ofits disclosure committee.

In June 2003, BEI announced that it had entered into a contract for a significant soil remediation project. In August 2003, the validity of that contract became questionable as a result of protests by a competitor of BEI. In June 2004,BEI entered into a second contract with respect to that same project but for much smaller volumes. In July 2004, BEI announced that shipments under the first contract were "highly unlikely," and that it had entered into the much smaller second contract.

In 2006, Bennett was reprimanded by the Ontario Securities Commission (OSC) for violating the disclosure requirements of applicable securities laws. Bennett admitted in a settlement agreement with the OSC that the existence ofthe dispute about the first contract in August 2003 constituted a material change and that BEI had failed to disclose that change in accordance with applicable securities laws. He was fined $250,000 and ordered to pay $50,000 in costs.

In December 2006, Bennett sought indemnification from BEI for the fine and the costs he had incurred in the OSC proceedings.BEI refused to indemnify Bennett, claiming he had not complied with the good faith and lawful conduct requirements contained in paragraphs 124(3)(a) and 124(3)(b) of the CBCA. Those provisions prohibit a corporation from indemnifying a director unless (a) the director acted honestly and in good faith with a view to the best interests of the corporation, and (b) in the case of a criminal or administrative action or proceeding that is enforced by a monetary penalty, the director had reasonable grounds for believing the director’s conduct was lawful.

The court held that the corporation had the onus to show that Bennett did not act honestly or in good faith with a view to the best interests ofthe corporation, and that Bennett did not have reasonable grounds for believing his conduct was lawful. This onus made sense, the court held, because the corporation "will most likely have the advantage of unrestricted access to corporate documents relevant to the indemnification proceeding." The court also affirmed that the good faith test under paragraph 124(3)(a) is a subjective one.

The court agreed with the conclusion of the lower court that BEI had failed to establish that Bennett was not credible in showing he had acted honestly and in good faith with a view to the best interests of the corporation. The surrounding circumstances indicated that Bennett’s belief in his good faith conduct was informed and the honesty of his belief was supported by the absence of any motive to withhold disclosure.

The court also concluded that BEI did not meet its onus to establish that Bennett did not have reasonable grounds to believe his conduct was lawful. Bennett honestly and reasonably believed that the first contract signed in June 2003 was not in jeopardy, so there was no basis for himto have believed he had a disclosure obligation under applicable securities laws.

The Bennett decision provides comfort to a corporate director that the corporation will not be prohibited from indemnifying him or her in advancing the interests of the corporation unless the corporation can establish that the director acted in bad faith or that the director did not have reasonable grounds for believing he orshe was acting lawfully.

McCarthy Tétrault Notes:

One interesting point raised in the judgment was whether a director had to have legal advice regarding the lawfulness of his or her conduct to be entitled to indemnification. The court stated that reasonable legal or professional advice is not a prerequisite to indemnification, but that having obtained such advice will establish reasonable grounds for beliefthat the director’s conduct was lawful.

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