Canada: Bill C-57 – A Revised Corporate Governance Regime for Financial Institutions Doing Business in Canada

On November 25, 2005, Bill C-57, An Act to amend certain Acts in relation to financial institutions ("Bill C-57"), received Royal Assent. While Bill C-57 has not yet been proclaimed in force, we expect it to become law in the near future. Regulations will need to be promulgated to give effect to some amendments.

Bill C-57 amends the Bank Act (the "Bank Act"), the Insurance Companies Act (the "ICA"), the Trust and Loan Companies Act ("TLCA") and the Cooperative Credit Associations Act (the "CCAA") (collectively the "FI Acts"). These amendments primarily change the corporate governance provisions in these statutes such that they will be largely consistent with the 2001 amendments to the Canada Business Corporations Act ("CBCA").

Certain amendments in Bill C-57 relate to the capital structure of financial institutions. Previously, when a financial institution issued shares to a person in consideration for property, including shares of or ownership interests in a body corporate or other entity to which shares in the financial institution were issued, that consideration could only be recorded in the stated capital account of the issuing financial institution if such shares were issued to non-arm’s length persons (as defined in the Income Tax Act (Canada)). Amendments to the FI Acts permit property received from arm’s length persons (as defined in the Income Tax Act (Canada)) in consideration for the issuance of shares of a financial institution to be recorded in that financial institution’s stated capital account, provided that the issuing institution and all of the holders of the class or series of shares issued consent to the transaction.

A financial institution may also permit its subsidiaries to acquire shares of or ownership interests in it, or in an entity that controls it, if conditions to be prescribed are met. In addition, and perhaps as a recognition that it is impractical to require each security certificate of a financial institution (especially those which are widely held) to be signed manually by the required officer of the financial institution, the FI Acts have been amended to permit signatures on security certificates to be mechanically reproduced.

The way in which shareholders of a financial institution are permitted to participate in meetings has been amplified. For example, shareholders may now participate in and vote at meetings of shareholders by electronic or telephonic means.

In addition to revised and expanded participation provisions in the FI Acts, requirements relating to shareholder proposals have been enhanced. Eligible shareholders (members in the case of institutions governed by the CCAA) are able to submit notice of matters that they propose to raise for discussion at the next meeting of shareholders. To be eligible to make a proposal, shareholders must meet certain requirements which are to be prescribed by regulation. Shareholders are permitted to provide a statement in support of a proposal in a form and length prescribed by regulation. No regulations have been prescribed at this time; however, it is likely that the permissible length of such a statement will be increased from 200 words to 500 words in order to be consistent with the CBCA.

The foregoing provisions relating to shareholders of financial institutions also apply to policyholders of insurance companies with necessary modifications.

The concept of insider trading in respect of publicly traded financial institutions has been expanded in the Bank Act, the TLCA and the ICA. The definition of what constitutes an "insider" has been expanded. The revised definition, among other things, includes any person who controls a prescribed number (currently more than ten percent) of the financial institution’s voting shares and includes a director or officer of a corporation that enters into a business combination with the financial institution. Insiders are liable to compensate adversely affected buyers and sellers of financial institution securities where they knowingly make use of, or disclose, confidential information. Prohibited insider trading now applies to all securities of the financial institution, not just its shares, thereby including its debt obligations. Guidance has also been given to courts for measuring damages relating to insider trading.

A process for going-private and squeeze-out transactions has been added to the Bank Act, the TLCA and the ICA. A going-private transaction is a transaction as defined in regulations to be promulgated. Assuming the definition of this term is the same as that currently found in the CBCA, a going-private transaction would be a transaction that results in the interest of a holder of a class of shares in those shares being terminated without that shareholder’s consent and without the terminating entity substituting an interest in a class of shares of equal or greater value than the interest which was terminated. Financial institutions may undertake going-private transactions only if they comply with provincial securities laws.

A squeeze-out transaction is essentially a going-private transaction for private entities; that is, a squeeze-out transaction is a transaction that results in the interest of a holder of a class of shares in such shares being terminated without that shareholder’s consent and without the terminating entity substituting an interest in a class of shares of equal or greater value than the interest that was terminated. Squeeze-out transactions may only be carried out with the consent of each class of shareholders affected by the proposed transaction, regardless of whether the holders of such shares normally possess the right to vote. Consent need only be granted by way of an ordinary resolution of the shareholders not by special resolution of those shareholders.

In order to protect the rights of shareholders, shareholders may dissent in the event of a going-private or squeeze-out transaction and dissenting shareholders have the right to be paid the fair market value of the shares subject to the transaction by the institution. Courts have also been granted an oversight role with respect to disputes arising from going-private or squeeze-out transactions.

Several Bill C-57 amendments affect directors and officers of financial institutions. For example, a director must now consent to his or her election or appointment to the board of directors for such election or appointment to be considered valid. Directors have also been afforded a due diligence defence in respect of statutory liability, liability for wages, liability arising from prohibited transactions under the FI Acts and liability in respect of directors’ general duties. The due diligence defence replaces the former good faith reliance defence, which absolved directors of financial institutions from liability where they relied in good faith upon the report of an accountant, actuary, lawyer, notary or other professional person whose profession lends credibility to a statement made by the professional person. This change is an improvement as the due diligence test has become the nearly universal standard by which the duty of care of directors is examined and, therefore, has more relevance.

In addition to the due diligence defence for directors, the indemnification provisions in the legislation now extend to an individual who acts or acted at the financial institution’s request as a director or officer or in a similar capacity, not only for the financial institution but also for another entity, where the person acted in the best interests of the financial institution or the other entity.

A financial institution may advance funds to a director, officer or other person to defray costs of a proceeding, including an investigative proceeding, but beneficiaries must repay those funds if it is determined that they were in breach of their fiduciary duties.

The provisions governing disclosure about material contracts or transactions in which a director or officer has an interest have been amended. Directors and officers are now required to disclose a material change in the nature of their interest in a party to a contract or a transaction with the financial institution. Shareholders are entitled to examine portions of minutes of directors’ or committee meetings where such disclosure is made. Where the disclosure obligations placed on directors are not met, a contract or transaction is not rendered invalid and a director or officer of a financial institution may not have to account to the financial institution for the profits of a contract or transaction, if shareholders (with sufficient disclosure) confirm or approve the contract or transaction by special resolution and the contract or transaction was reasonable and fair to the financial institution at the time it was approved or confirmed.

Certain amendments provide for greater legal recognition of the uses of technology and electronic documentation. Information required to be given in writing may be satisfied by an electronic document that meets requirements to be prescribed, which include the shareholders consenting to the receipt of such communication by electronic means.

In addition, perhaps in recognition of the increased reliance on telecommunications, provision has been made in the legislation for the execution of corporate documentation in counterparts.

Under conditions to be prescribed, there will be greater flexibility for a subsidiary of a financial institution to acquire shares of the financial institution, or shares or ownership interests of an entity that controls the financial institution. Regulations will likely be substantially similar to the conditions described in the Canada Business Corporations Regulations, which permit a non-Canadian subsidiary to acquire shares of a Canadian business corporation to facilitate the non-Canadian subsidiary to acquire by merger, takeover or other business combination a foreign target corporation.

Proxy solicitation rules have been amended. Certain public announcements, communications to obtain support for a shareholder proposal or communications in circumstances to be prescribed are not included in the definition of a proxy solicitation and the threshold for the requirement to solicit proxies has increased from 15 to 50 shareholders. An intermediary holding shares of a financial institution may now appoint a proxy holder to cast, on behalf of the intermediary, the votes corresponding to the shares held by the intermediary.

Instead of the current specific list of holding bodies corporate that may apply to exempt a financial institution subsidiary from the requirement that thirty-five percent of the financial institution’s shares be publicly traded approximately three years after the financial institution achieves $1 billion in equity, a financial institution itself may now make an application to the Minister of Finance (Canada) (the "Minister") and the Minister may exempt the financial institution from those requirements if the Minister considers it appropriate to do so. This amendment is found only in the ICA and the TLCA and provides to insurance companies, insurance holding companies and trust and loan companies the same rights regarding making an exemption application that are currently provided to banks.

None of the foregoing amendments relating to publicly traded companies applies to institutions governed by the CCAA.

The independence criteria for the auditor of a financial institution have been strengthened. Where a financial institution proposes to replace an auditor, the financial institution may make a statement about the reasons for the replacement, and the proposed replacement auditor may comment on those reasons, which information must be provided to voting shareholders and to the Superintendent of Financial Institutions (Canada).

Fines under the FI Acts have been increased. Individuals convicted of an offence on indictment will be liable for a fine up to $1,000,000 (an increase from $500,000), or for imprisonment up to five years, or both. If a convicted person or the person’s spouse obtained a monetary benefit from the commission of such an offence, despite any other fine imposed, a court may impose an additional fine in an amount equal to three times the court’s estimate of the amount of the benefit.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.