Who’s the Piper: Dual Loyalties of Directors?

The Situation

A director of a sport organization is appointed to the board because of his or her position in another organization or because that organization has voted the person to be its representative. These organizations are typically stakeholders in the organization (e.g., a provincial or territorial sport organization or a regional or club member). The question is… to whom does the director first owe a loyalty – the organization that put them there or the organization of which they are a director? Indeed, they may be a director or officer of both organizations. Which loyalty takes precedence?

The Potential Problem

Such directors are known as ex officio directors (ex officio is a Latin phrase meaning appointed by virtue of one’s position). The ex officio position continues within the framework of the new Canada Not-for-profit Corporations Act (NFP Act). In some cases, organizations may have to reduce the number of ex officio directors under the new legislation [1]; but nonetheless, such directors remain an important part of many boards’ complement. The issue is that these directors typically face joint loyalties – loyalty to the nominating organization and loyalty to the organization of which they are a director.

This post explores the issue of dual loyalties and some of the ways to deal with it. The issue has not been largely explored; nonetheless, there are some clear principles that have emerged from the case law.

First, directors DO have various legal duties. These can be grouped into 2 main categories: the duty of loyalty and the duty of care. These are more fully described in the new NFP Act:

148. (1) Every director and officer of a corporation in exercising their powers and   discharging their duties shall:

(a) act honestly and in good faith with a view to the best interests of the corporation; and

(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
The duty of loyalty (referred to in sub-section (a) above) is fairly straightforward. A director owes a legal duty to the body of which he or she is a director. The scope of the duty has been summarized as follows [2]:

  • to act in the best interests of the organization at all times;

  • not to favour the interests of the organization from which the director’s appointment arose (i.e., the stakeholder), if the stakeholder’s interests differ or conflict with those of the organization;

  • not to disclose the organization’s confidential information to the stakeholder; and,

  • to disclose corporate information coming from the stakeholder which relates to a transaction or operation likely to have a negative impact on the organization of which the person is a director.

The first two bullets refer to the need to act independently of the stakeholder organization (and in the best interests of the organization of which one is a director) and the last two refer to the disclosure of confidential information (again, in the best interests of the organization of which one is a director).

Obvious problems can arise: if the director is also a director or officer of the stakeholder organization, there will be an identical and separate set of duties, but this time to the stakeholder organization. This situation arises where, for example, regional representation on a national board is at issue, or club or regional representation on a Provincial or Territorial board occurs. As a director, the individual may feel obliged to represent the stakeholder’s interest. The director may be put in a state of virtual paralysis in terms of the duty of loyalty.

Solutions

Some organizations deal with the situation as a conflict of interest matter. This approach isn’t entirely satisfactory; in fact, it does little to address this situation specifically. It doesn’t address the confidential information issue and can create even more problems for a director who cannot weigh in on a vote (because of the directive of the conflict of interest policy) but may be stuck with any liability arising out of the implementation of the result of the vote – that is to be the content on my next blog on specific aspects of director liability.

Case law has established that a director may take into consideration the interests of the various stakeholders in determining what might be in the best interests of the organization. And, as long as reasonable judgment is exercised, in good faith, the courts will not typically second-guess the decision. This is known as the ‘business judgment rule’ and comes from the for-profit sector. It is tricky to make the translation to the not-for-profit world where shareholder profit does not translate into stakeholder benefit, and which, in any event, is not the primary mission of the not-for-profit organization. It would seem, however, that the best interests of the organization would still prevail but the interests of the stakeholder may be promoted if they are consistent with the best interests of the organization. But make no mistake, the duty of the director is owed primarily to the organization, not the stakeholder. (Re London Humane Society. 2010 ONSC 5775 (CanLII))

Once a board decision has been made, the director’s duty becomes one of neutrality between the organization and the stakeholder.  As described by Clifford Goldfarb [3], “A director who publicly opposes or covertly works against the decision [of the board] is doing so at his or her peril.”

Here is what the experts say [4]:

[The director’s duty of loyalty] requires a director to accept decisions validly made… While such a director can…vigorously promote the views that have been espoused by the [stakeholder] board, all directors must accept the decision of the majority of directors of the board once the vote is taken, regardless of whether the vote does or does not support the stance taken by the [stakeholder] board, and the views promoted by the director common to both. Although such a director is free to indicate, even publicly, what views the person holds on the particular topic, he/she should not actively promote a viewpoint that is contrary to the decision made by that [stakeholder] board, while at the same time representing himself/herself as a director or spokesperson of the [stakeholder] board. He/she should make it very clear that his/her views are either personal or those of the board of which he/she is a director, not the position of the [stakeholder].

Confidential Information

On the issue of confidential information, the case law suggests that it is indeed, a one-way street. Where a director of an organization is concurrently a director of a stakeholder organization, and if confidential information of the stakeholder could have a material negative impact on the organization, then the director must disclose that information. Confidential information of the organization of which the individual is a director may not be shared with the stakeholder organization.

Conclusion

Many problems arise because people do not understand their roles or responsibilities as Board members. They also arise because of the inherent conflict within the representational ex officio board position. Educating directors about their roles and the legal duties that flow with those roles is crucial – and only fair to such directors. It is also important for boards and, in particular, chairs of boards to understand the complex and inherently difficult nature of the ‘dual loyalty’ director.  That said, it does not resolve the conflict of a board member of a stakeholder organization who is, by virtue of that position, also an ex officio member of the board of another organization. Some organizations deal with the matter by making ex officio directors non-voting directors. That too, may not solve the problem.

------------------------------

[1] One ex officio position for a one-year term for every 3 positions elected at the previous annual meeting  (Section 128(8) of NFP Act).

[2] Goldfarb, Clifford, S. (2011). “Dual Loyalties on Non-Profit Boards: Serving Two Masters”. CBA-OBA National Symposium on Charity Law, at 8.

[3] Ibid, 25.

[4] Kelly, H. amp; Berry, R.R. (2005). Conflict of Interest: one director, two boards, the difficulty of serving two masters. Charities & Not-for-Profit Newsletter. Miller Thomson LLP.

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