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Holding directors to a higher standard.

Even in the bleakest of financial times, the environment must not be a sacrificial lamb on the altar of corporate survival. So stated Ontario Court Judge Edward F. Ormston on April 6, 1992, as he pronounced sentence upon Bata Industries Ltd. and two of its executives for failing to attend to a discharge of toxic waste from one of its Batawa, Ontario storage facilities.

This most recent court decision against an environmental polluter and its executives has corporate attorneys and risk managers in Canada scrambling to understand its implications in the area of directors' and officers' (D&O) liability. A company's ability to indemnify its officers or directors and what standard of conduct (degree of involvement) is expected of them is just one of the issues at the heart of this case.

In 1986, Bata's vice president and onsite general manager, Keith Weston, had been made aware of the company's storage of chemical waste in drums and could have had them removed for C$56,000. Company President Douglas Marchant became aware of the storage problem in 1989 but failed to remove the drums until a Ministry of the Environment investigation led to the eventual cleanup. Since then, the company has accumulated nearly C$450,000 in environmental studies and cleanup costs that do not even include costs associated with the 27-day trial.

Bata Industries Ltd. was fined C$120,000 for violation of the Ontario Water Resources Act (OWRA) In the court's opinion, Mr. Weston could not demonstrate that he "took all reasonable care to prevent an unlawful discharge," while Mr. Marchant "showed a lack of due diligence" in delaying a cleanup of the site by failing to see that his instructions and company policies were carried out.

Mr. Weston and Mr. Marchant were held by the court to be personally liable for breaches of OWRA and fined C$12,000 each. Under Ontario's Environmental Protection Act, the two could also have been exposed to imprisonment or held personally responsible for the cleanup costs. All parties were acquitted of these charges. (Bata Industries and the two executives, deeming the fines to be excessive compared with other cases, has appealed the sentence - not the conviction.)

Also charged, but acquitted, of violating these environmental statutes was Thomas G. Bata, the company's chairman of the board. "Notwithstanding Mr. Bata's acquittal," cautions Caroline Findlay, an environmental law expert with Tory Tory DesLauriers & Binnington in Toronto, "the case does not stand for the general proposition that a lack of knowledge by directors and officers will exculpate them." Mr. Bata established that he did everything reasonably possible for a person in his position to prevent such an occurrence. The judge also held that Mr. Bata was entitled to assume that the experienced professionals that he had placed under him would follow his firm's environmental responsibilities as stated in his technical advisory circular and bring any problems to his attention.

"Today, the board of directors is being held to a higher standard of conduct, including ensuring workplace safety, as well as environmental compliance," says Leslie Tenenbaum, Bata industries' in-house legal counsel, adding that "the mere delegation of authority is no longer a sufficient defense." According to Ms. Findlay, "this is the first case in which an Ontario court has given extensive consideration to the legal obligation of directors and officers of polluting businesses.

Ms. Findlay further notes that "this case provides an instructive factual context for corporations and their officers and directors to understand the standard of conduct the courts expect of them." Judge Ormston expects the directors of a company to be responsible for reviewing environmental compliance reports, substantiating that officers are promptly addressing environmental concerns and personally reacting when the compliance system fails.

"The potential exposure to personal liability is staggering," notes John Nicholl, a law partner with Ogilvy Renault in Montreal. "And it is open to doubt whether a federally incorporated firm [Bata was incorporated in Ontario] would be able to indemnify a director or officer, in the event of a conviction," under certain provisions in the Canada Business Corporations Act.

Other precedents were established as well. Mr. Tenenbaum points out that this is the first time that a judge has prohibited a company from indemnifying its officers or directors. "Without judicial precedence or authority," he holds, "the judge has preempted a company's right to indemnify if it so chooses."

At the outset of the trial, the prosecutor had to show beyond a reasonable doubt that the accused had not acted with due diligence. Remarkably, during the course of final arguments, the Supreme Court of Canada, ruling on another case, shifted the burden of proof onus by holding that for reguiatory offenses, "on the balance of probabilities," the accused were required to prove they were not negligent. Thus, by the end of the trial, Mr. Nicholl stresses, "instead of being given the benefit of any doubt as to diligence, the accused now had the onus of meeting a civil burden of proof in order to succeed."

A hitherto internal corporate issue was thus brought out by this trial that company executives now need to rethink "For a long time," Mr. Nicholl notes, "the attitudes of directors and lawyers was that the less you write, the better off you were. But now we find that failing to keep records can be tantamount to cutting one's own throat, since the onus now is on the defendant to produce evidence of acting with due diligence."

Considering that any available D&O liability insurance would inevitably contain exclusions with respect to fines or penalties imposed by law and with respect to the consequences of pollution, what can risk managers do to assist their directors and officers? Joseph MacDonald, risk manager for Sherritt Gordon Ltd., an integrated fertilizer, chemical, oil and natural gas producer in Fort Saskatchewan, Alberta, suggests that "when dealing with environmental risks, prevention, rather than indemnification, should be the focus of the organization. The risk manager must play a leading part in promoting this philosophy to senior management." He also notes that the board "must be advised of the breadth, and more importantly, the limitations of their insurance protection."

Mr. MacDonald further advises that organizations should have a formal (or, for smaller firms, an ad hoc) environmental committee comprising members of the board of directors. "This committee should be active in the organization's environmental management wherein they are kept fully informed of exactly what the plant management is doing regarding environmental loss control and looking for proactive measures to implement."

David Rikley, manager of risk and claims for Union Gas Ltd, Chatham, Ontario, says that his company's managers constantly go through a series of checklists and discussions on liabilities and responsibilities. "We are communicating all the time. Our company has always been proactive environmentally, very loss control conscious."

"Every time we read in the newspaper a judgment against an incidental polluter, it puts us risk managers in a tailspin," states Susan Meltzer, risk manager for Bell Canada in Toronto. Mr. Rikley's experience at Union Gas has been that "after these cases hit the papers, D&O cover becomes quite prominent on the board's agenda at our yearly overview meetings." Meanwhile, Mr. MacDonald points out that "these cases go a long way toward emphasizing the risk manager's continuing need to make the board members aware of these situations and their consequences."

Perhaps there is a realization that some governments are getting serious about environmental prosecution. Typically, only the line manager was subject to such prosecution. Mr. Nicholl finds that after the Bata decision, "senior executive management sees that their conduct could be subject to examination in minute detail by the courts."

"Right now," Mr. Tenenbaum maintains, "the environmental issue is a very hot topic. It was less so back in 1986, when Mr. Weston made his fateful decision. In hindsight, and based on a 1991 standard, perhaps he would have acted differently."
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Title Annotation:Canadian Quarterly; directors' and officers' liability
Author:Kurland, Orin M.
Publication:Risk Management
Date:Jul 1, 1992
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