Business Law Blog

In the fall of 2015, the well-known corporate lawyer Martin Lipton issued a paper entitled Will a New Paradigm for Corporate Governance Bring Peace to the Thirty Years’ War. Focused on what were then widespread concerns about corporate short-termism and, more particularly, the effect of activist hedge funds on long-term corporate value, this article was a prelude to Mr. Lipton’s publication of a document for the International Business Council of the World Economic Forum describing what he called a “New Paradigm” for corporate governance.^[1]

The intervening years have witnessed an explosion of dialogue on the role and purpose of corporations, and the corporate governance discourse in the United States, Canada and beyond is flush with frameworks, guidelines, articles and proposed laws and regulations, all supported by various combinations of investor groups, experts, academics, politicians and regulators, that call for myriad changes to the way corporations ought to be governed. As a result, while the specifics of what a new paradigm might ultimately entail remain unresolved, and while the vocabulary used to describe the problems it may address and the means to address them continues to develop, the trend has been clear and the momentum considerable. In particular, the force behind what the World Economic Forum and others have begun calling “stakeholder capitalism”^[2] has intensified, with the shareholder-focused philosophy of prior decades clearly on the wane.^[3]

Outside of the somewhat arcane discourse on corporate governance, society is straining for a better understanding of what role corporations - and business more generally - should play in the lives of citizens, and those within the discourse are struggling with whether and how law and regulation should promote the evolving ethos.^[4] What must not be lost as we proceed through this crossroads is that the duties of corporate directors unequivocally arise out of corporate law.

There is a torrent of profoundly important issues facing society in our time, many of them amounting to real crises. Directors are not automatons, and will have views on how law and policy generally should address those issues. But corporate directors, as such, at least in Canada, are obliged to act in the best interests of the corporation they serve. Their role is not to implement policy, and certainly not to use their corporations to enforce the prevailing morality of their time. As the specifics of “stakeholder capitalism” become clearer, driven by the incredible momentum of the last few years, and as pressures mount on corporations to react to external crises, directors of Canadian corporations must keep their corporate duties as the lodestar of their decisions. This article is intended as a brief reminder of what those duties entail.

The Fiduciary Duty in Canada and the Primacy of Purpose

Most broadly, the board of directors is the steward of the corporation. Under the federal Canada Business Corporations Act (the “CBCA”), as well as the major provincial corporate statutes, the directors are charged with managing or supervising the management of the corporation’s business and affairs. This general duty, in turn, is subject to two other duties, known as the “fiduciary duty” or “duty of loyalty” and the “duty of care,” which set standards of behaviour that guide the general rule. The fiduciary duty, specifically, requires that a director “act honestly and in good faith with a view to the best interests of the corporation.” This duty, under which a director is made a fiduciary of the corporation itself, is a linchpin of corporate law, intended to provide assurance that those with control of the corporate endeavor will not divert some portion of its benefits to themselves.^[5]

While Canadian courts struggled in the latter years of the twentieth century to reconcile the fiduciary duty with certain elements of Delaware corporate law, particularly relating to so-called Revlon duties,^[6] the Supreme Court of Canada’s decisions in Peoples Department Stores Inc. (Trustee of) v. Wise^[7] in 2004 and BCE Inc. v. 1976 Debentureholders^[8] in 2008 erased any doubt that the directors’ loyalty is owed only to the corporation, regardless of context, and not to its shareholders. Further, the Supreme Court pronounced in the BCE decision that in considering the best interests of the corporation, the directors may need to consider the interests of stakeholders affected by its decisions, as those stakeholders are entitled to be treated equitably and fairly.^[9]

With the fiduciary duty cast in this way, the challenge for Canadian boards of directors is to determine what the “best interests” of their corporation are in any given context, and to identify who holds a stake in the corporation worthy of their consideration. While the fading spectre of shareholder primacy offered a simplistic answer to these questions, and while its echoes can still be heard in some boardrooms, the evolution of corporate governance towards a new paradigm has offered a variety of principles and a growing vocabulary that can help address that challenge.

In particular, the doctrine of “corporate purpose,” which I have explained in greater detail in prior posts,^[10] offers a coherent way for directors and executives to understand and comply with the Supreme Court’s interpretation of the fiduciary duty in Canada, as well as the recent amendments to the CBCA. Specifically, once the corporation’s purpose has been articulated, its best interests are, at least broadly speaking, quite clear: to achieve that purpose. Further, a clearly articulated purpose facilitates the long-term strategic planning required for durable value creation. Long-term planning requires a thorough assessment of stakeholder interests, as a long-term strategy cannot ignore the social, cultural, environmental and economic trends that impact the business and those that interact with it. To ignore those trends would almost surely render the business unsustainable.

In short, understanding the “purpose” of any given corporation is the key to understanding the Canadian concept of the fiduciary duty as it applies to that corporation, and the pursuit of purpose is inseparable from a focus on the corporation’s sustainability.^[11]

Purpose and Sustainability

There is no doubt that, from an investor’s perspective, corporate sustainability has become a crucial factor in making investment decisions.^[12] While the language used to assess the factors relevant to a business’s sustainability has expanded from the idea of “corporate social responsibility” and its cousin “social license,” to the acronyms intended to encompass more specific non-financial factors that affect value, such as “E&S,” “ESG,” “EESG” and “ESG&D,” the concept that investors are seeking to understand, in the context of each specific business, is whether the pursuit of its purpose is sustainable over the long term, given the social, cultural, environmental and economic trends that prevail at any given time. Climate change likely affects every business over the long term, but it affects each business differently. Income inequality also likely affects every business over the long term, but it too affects each business differently. Management, overseen by the board as part of its risk management and strategic oversight function, but also in setting a tone that drives purpose and sustainability throughout the firm, must determine what those effects are, what they will be, and how the corporate strategy will engage those and other issues as the corporation progresses towards its purpose.

To put this plainly, it is not the job of every corporation, nor its board, to solve the climate crisis, reduce income inequality and end gender inequality and systemic racism.^[13] Those are purposes to be pursued by governments and societies more generally. However, every corporation has a role to play in those important societal objectives, not necessarily by engaging in activities extraneous to its business, but by fulfilling its purpose, by creating the product or service it was formed to produce in a profitable and sustainable way. If all Canadian corporations pursue their purposes with an eye to sustainability, in theory at least those larger objectives will be easier to achieve for Canadian society as a whole, as it will be more prosperous over a longer period. That is the alchemy of combining the ingenuity and efficiency engendered by a capitalist economic system, in which corporations play an invaluable role, with the fairness for which our democratic political system strives.

The Gravity of the Fiduciary Duty

In spite of the pace of change and the proliferation of views and guidance on new modes of corporate behaviour, how the overarching philosophy of corporate governance will resolve itself in Canada and beyond remains to be seen.^[14] In the meantime, corporate purpose has presented an evolved way of understanding how corporations ought to behave where the prior philosophy has not only become outmoded, but proved itself wholly inadequate to satisfy the needs of the community.

In Canada, the current corporate law regime already accommodates the change in practice that the doctrine of corporate purpose demands. There is ample reason to believe that our formulation of the fiduciary duty already requires consideration of stakeholder interests, a commitment to “purpose” and a view to the long term sustainability of the business. No change in the law, either by legislatures altering the fiduciary duty or by courts expanding pre-existing corporate remedies, is needed.^[15] If our goal as a society is for corporations to be governed more wisely, with a longer term view informed by sustainability, a new paradigm already exists in Canada – as a matter of law, if not yet always in practice – and it begins with purpose.

_{[1] Martin Lipton, The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth.}

_{[2] See, for example, Klaus Schwab, Stakeholder Capitalism, 2021, in which “Stakeholder Capitalism” is defined as “a form of capitalism in which companies do not only optimize short-term profits for shareholders, but seek long term value creation, by taking into account the needs of all their stakeholders, and society at large.” See also the Davos Manifesto 2020 and the “Stakeholder Capitalism Metrics” set forth in the World Economic Forum’s white paper entitled Measuring Stakeholder Capitalism – Towards Common Metrics and Consistent Reporting of Sustainable Value Creation.}

_{[3] The concept of “stakeholder capitalism” is intended to imply an evolution from the “shareholder capitalism” that has prevailed for the last half century, and that relies on the theory of “shareholder primacy” that holds, effectively, that the directors of a corporation are agents of the shareholders and thus bound to act in their interests. For a brief discussion of the doctrine of shareholder primacy and how the concepts of purpose and stakeholder interests are eclipsing its influence, see my August, 2019 post, The Business Roundtable and the Continuing Trend from Primacy to Purpose, which discusses, among other things, the Business Roundtable’s about-face on its commitment to the “primacy” of shareholders and endorsement of a commitment to corporate purpose. See also the following quotation from the September 2020 Wachtell Lipton Rosen & Katz memorandum entitled The Friedman Essay and the True Purpose of the Business Corporation, discussing the waning of shareholder primacy and the ideas of the economist Milton Friedman on which it is founded:}

_{“This concept of capitalism took hold in the business schools and the boardrooms, became ascendant in the eighties and continued as Wall Street gospel until 2008, when the perils of short-termism were vividly illuminated by the financial crisis, and the long-term economic and societal harms of shareholder primacy became increasingly urgent and impossible to ignore. Since then, acceptance of and reliance on the Friedman doctrine has been widely eroded, as a growing consensus of business leaders, economists, investors, lawyers, policymakers and important parts of the academic community have embraced stakeholder capitalism as the key to sustainable, broad-based, long-term American prosperity.”}

_{[4] See, for example, Mervyn King S.C., Paul Polman, Kerrie Waring, Bob Moritz and Gilbert Van Hassel, Call to Action on Sustainable Corporate Governance, March 2021.}

_{[5] The need for a legal technology to attenuate this element of human nature is not new. As Adam Smith wrote of joint-stock companies in his Wealth of Nations in 1776: “The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.”}

_{[6] CW Shareholdings Inc. v. WIC Western International Communications Ltd. (1998), 160 D.L.R. (4th) 131 (Ont. Gen. Div.), at para. 41; the court's decision in WIC endorsed Revlon Inc. v. MacAndrews & Forbes Holdings, 506 A.2d 173 (1986).}

_{[7] Peoples Department Stores Inc. (Trustee of) v. Wise, [2004] 3 S.C.R. 68.}

_{[8] BCE Inc. v. 1976 Debentureholders, 2008 SCC 69.}

_{[9] Ibid. at para. 82. For further commentary on this pronouncement and of recent amendments to the CBCA that purportedly enshrined aspects of the BCE decision into the CBCA, see my April, 2019 post Corporate Duties, Indeterminacy and the 2019 Federal Budget.}

_{[10] See, for example, Stakeholder Interests – A Canadian Perspective, A Sense of Purpose and the New Paradigm: Governance Trends Apparent in Larry Fink's Annual Letter to CEOs, The New Corporate Governance: Corporate Purpose and Corporate Leadership and The Business Roundtable and the Continuing Trend from Primacy to Purpose.}

_{[11] The Supreme Court stated in the BCE decision at para. 38: “The fiduciary duty of the directors to the corporation is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an ongoing concern, it looks to the long-term interests of the corporation.” In other words, the fiduciary duty is not a monolith imposed on every corporation in the same way, but rather must be wrought into a unique form for each, taking into account the unique constellation of risks, opportunities and stakeholders that its business engages.}

_{[12] See, for example, public letters and other statements from major asset managers, including: (a) 2020 Letter to CEOs from Larry Fink, CEO of Blackrock, which, in the context of declaring a “fundamental reshaping of finance,” states: “Our investment conviction is that sustainability- and climate-integrated portfolios can provide better risk-adjusted returns to investors. And with the impact of sustainability on investment returns increasing, we believe that sustainable investing is the strongest foundation for client portfolios going forward;” (b) Mr. Fink’s 2021 Letter to CEOs, which states: “As more and more investors choose to tilt their investments towards sustainability-focused companies, the tectonic shift we are seeing will accelerate further. And because this will have such a dramatic impact on how capital is allocated, every management team and board will need to consider how this will impact their company’s stock;” (c) The January 2021 letter from Cyrus Taraporevala (President and CEO of State Street Global Advisors) entitled CEO’s Letter on Our 2021 Proxy Voting Agenda, which states: “we continue to believe that working with boards such as yours on a range of environmental, social, and governance best practices will help create a more resilient, sustainable, and inclusive future for companies, economies, and societies;” and (d) Vanguard’s statement that “Climate change represents a profound, fundamental risk to investors’ long-term success, and… it is critical that public company boards fully understand and own climate-related risks.”}

_{[13] This is not to say that it cannot be embedded in a company’s purpose to play a role in solving any of those issues. See, for example, the outdoor clothing company Patagonia, which as a public benefit corporation has enshrined purposes related to the climate crisis in its corporate constitution. For more information on “benefit companies,” as they are called under British Columbia corporate law – the only jurisdiction in Canada in which such entities are available – see my June, 2020 post, Benefit Company Legislation Comes Into Force in British Columbia.}

_{[14] The BCE decision remains the authority in Canada on the fiduciary duty of corporate directors, as well as on other elements of corporate law, and as noted the recent amendments to the relevant provisions of the CBCA are expected to make little practical difference in how boards behave or are scrutinized by courts. The consistent approach to Canadian corporate law, however, is in contrast to securities regulation in Canada, which can evolve at a faster pace and react to the demands of investors in a way that corporate law does not. For example, in Staff Notice 51-358 – Reporting of Climate Change-related Risks, provincial securities regulators acknowledged the focus of investors on climate change-related issues and offered guidance on the disclosure by public companies of risks related to climate change. See also the recent recommendations in the Final Report of the Capital Markets Modernization Taskforce in Ontario, which include a recommendation to “mandate disclosure of material ESG information, specifically climate change-related disclosure that is compliant with the TCFD recommendations for issuers through regulatory filing requirements of the OSC.”}

_{[15] For example, federal and provincial corporate laws provide various formulations of what is known generally as the “Oppression Remedy.” Briefly, under the CBCA the oppression remedy is an equitable remedy available to various classes of persons where any act or omission of the corporation effects a result, the business or affairs of the corporation are conducted in a manner, or the powers of the directors are exercised in a manner that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of the claimant. The determination of whether a remedy is warranted includes an analysis of the claimant’s reasonable expectations. A claimant can be any person the court considers appropriate to bring an application, but given the practical realities of the remedy, it is most often associated with claims by minority shareholders, directors and creditors.}