In addition to good corporate management, and careful due diligence by the directors, there are a couple of other ways to manage the potential personal liability of your company’s directors.

In order to attract the best individuals to sit on their board, it is common for companies to offer directors protection from the liabilities they will be exposed to. Most companies provide a standard directors indemnity in their by-laws and some will provide a contractual indemnity.   This is standard practice, and companies that don’t do it will generally be looked on as questionable.

However, since an indemnity is only as good as the financial strength of the corporation giving it, some companies obtain Directors and Officers (“D&O”) insurance. This insurance, offered by specialty insurers in Canada, is supposed to ensure that directors get indemnified regardless of whether an indemnity from the corporation is available or sufficient. 

In practice, D&O insurance is often not a good bet for small companies.   Not only are the premiums very high (usually more than $10,000 a year, sometimes much more), but the policies have extensive exclusions, meaning that in most of the cases in which liability could arise, the policies don’t cover it. If you are looking at D&O insurance, the best advice is: a) shop around, and b) read the fine print.

Another solution to the liability problem is to have an advisory board instead of a board of directors. Often called a “TAB” (Technical Advisory Board), or “SAB” (Scientific Advisory Board), in fact they are simply a group of advisors or mentors, with no decision-making power, who meet with management periodically and provide input into what you’re planning to do. Often you can refer to them in your company literature or on your web site, so that outsiders realize that respected senior people are involved as advisors to the company. This doesn’t have as much positive impact as a strong board, but it still helps.

There are no formal rules for advisory boards, but two principles should be followed if you want your advisory board to be useful:

• It’s Not Just for Show. You’re going to have to compensate your advisory board members with shares or options. Don’t waste it. Make sure you have regular meetings with them, give them good preparatory materials, and motivate them to be fully engaged and active in their analysis of the company.

• It’s Not Your Board of Directors.   Be careful not to slip into the trap of having your advisory board actually pass resolutions and make decisions. If you do, you run the risk that they will be considered “de facto” directors, and held liable just as if they were legally directors. Get their input, but make sure that your actual board makes all the decisions.

This summary is a general overview for the assistance of clients. It is no substitute for advice from an experienced and knowledgeable advisor, with full knowledge of the facts and issues relating to your particular situation. Please contact us, we would be happy to assist.