The Use of Holding Companies for Ontario’s Municipally Owned Electricity Utilities: Part 3 – Corporate Governance

Introduction

In the first article of this series, we described how holding companies (“HoldCos”) can be used to increase corporate control, mitigate risks and maximize business synergies. In the second instalment, we reviewed the historical development and use of HoldCos within the electricity distribution sector in Ontario. In this third and final segment, we conclude by exploring an array of corporate governance issues emerging from the use of HoldCos in this sector.

OBCA – Duties of Directors

Overview

Section 134(1)(a) of the Business Corporations Act (Ontario) (“OBCA”) requires that corporate directors “act honestly and in good faith with a view to the best interests of the corporation,” which is more commonly known as a director’s fiduciary duty or duty of loyalty.^[1] Section 134(1)(b) sets out another key concept – the duty of care. That provision provides that directors must “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.”^[2]

HoldCo Level

In Ontario, the vast majority of local distribution companies (“LDCs”) (and their HoldCos) are municipally owned, servicing most electricity consumers in the province.^[3] As a result, mayors or municipal councillors are often appointed to the boards of HoldCos.^[4] This may result in situations where the expectation of the municipal shareholder is that the director will “represent” the interests of the municipality at the board table.

The fiduciary duty, which also exists at common law, requires directors to act honestly and in good faith vis-à-vis the corporation. This includes (among other duties) the duty to avoid conflicts of interest.^[5] As a result, despite a HoldCo director being appointed or elected to a HoldCo board seat specifically on behalf of the municipality, this person owes a fiduciary duty to the corporation.^[6]

Owing a duty to the corporation means, indirectly, taking account of the interests of the shareholders. However, the interests of the shareholders should be considered on a collective basis, not in a way that provides preferable treatment to one shareholder over any other.^[7] This is especially the case in situations where a conflict arises between a director’s duty to the corporation and the interests of the shareholder that appointed that director. Despite potential pressure on the director by the appointing shareholder, the director’s duty is to the corporation and, indirectly, the shareholders’ collective interests.^[8] However, given the aforementioned fiduciary duties, a director should recuse themself from deliberations and not vote with respect to a matter when, at the HoldCo board level and in relation to such matter, a conflict arises between the interests of the HoldCo and the interests of the municipal shareholder that appointed such director (no matter how politically difficult this may be).

LDC Level

The fiduciary duty also extends to ensuring that stakeholders are treated fairly. In the seminal case of BCE Inc. v. 1976 Debentureholders, the Supreme Court of Canada formulated the criterion as follows:

[T]he question is whether, in all the circumstances, the directors acted in the best interests of the corporation, having regard to all relevant considerations, including, but not confined to, the need to treat affected stakeholders in a fair manner, commensurate with the corporation’s duties as a responsible corporate citizen.^[9]

In the context of the regulated LDC, ratepayers/customers should be viewed as key stakeholders.^[10] Thus, the fiduciary duties of directors at the LDC level are different from those at the HoldCo level. At the HoldCo level, the focus may be more on the interest of the shareholders (albeit, on a collective basis). Conversely, at the LDC level, the fiduciary duty should take into account the regulatory regime under which LDCs operate and the interests of distribution customers.^[11]

The Meaning of ‘Independence’

The meaning of “independence” can vary depending on the context.

LDCs are subject to the rules set out in the Ontario Energy Board (“OEB”) Affiliate Relationships Code (“ARC”). Section 2.1.2 of the ARC requires that at least one third of the LDC board must be made up of directors who are independent from any affiliate.^[12] Although the ARC does not define “independence,” it likely means that a director of an LDC should not also be a director or employee of any affiliate of the LDC.

Interestingly, the OEB suggested raising the independent director threshold from one third to more than 50% in its 2018 report, Best Practices regarding Governance of OEB Rate-Regulated Utilities, although this proposal was not implemented.^[13]

The OBCA does not contain any independence requirement for private companies. However, for publicly listed entities, it requires that at least one third of directors are not officers or employees of the corporation or any of its affiliates.^[14] Thus, the ARC requirements mirror the OBCA requirements applicable to public companies.

However, public companies must also comply with the independence requirements of applicable securities regulators and stock exchanges. Under the TSX Company Manual, for example, companies are required to have at least two independent directors, defined as a person who:

• is not a member of management and is free from any interest and any business or other relationship which in the opinion of the Exchange could reasonably be perceived to materially interfere with the director’s ability to act in the best interest of the company; and
• is a beneficial holder, directly or indirectly, or is a nominee or associate of a beneficial holder, collectively of 10% or less of the votes attaching to all issued and outstanding securities of the applicant.^[15]

Thus, the TSX criteria extend to business relationships (such as suppliers and advisors), as well as to holders of more than 10% of voting shares.

Finally, both the New York Stock Exchange and Nasdaq require that listed company boards have a majority of independent directors.^[16] The focus is on independence from management to ensure directors can exercise autonomous judgment. To qualify as independent for this purpose, directors are precluded from holding management positions at either the company or its parent(s)/subsidiaries, and former executives must wait three years after their departure before being considered independent.^[17] 

Thus, in selecting board members, LDCs, HoldCos and affiliates might consider these other criteria for independence, which extend beyond those applicable to LDCs as set out in the ARC.

Appropriate Skill Sets for Directors

The skills and experience of a director considered desirable at the HoldCo level may differ from those desired in the LDC or unregulated affiliate.^[18] Experience in municipal politics, governance and strategy may be sought at the HoldCo level. Conversely, the LDC directors might emphasize regulatory, operational and engineering skills. Finally, unregulated affiliate directors could focus on entrepreneurial skills and experience in the competitive environment.

Shareholder Agreements and Directions

Under s. 108 of the OBCA, a shareholder may limit or restrict the powers of the directors of the corporation.^[19] This is generally done so that fundamental decisions with regard to the corporation, such as strategic transactions, financing and governance matters, require shareholder approval (in addition to board approval). Where a shareholder agreement or direction applies to a HoldCo, it may also reach “downward” to create shareholder approval requirements relating to the HoldCo subsidiaries, such as the LDC or unregulated affiliate.

It is important to note that, to the extent that the agreement restricts the discretion or powers of directors to manage or supervise the management of the business and affairs of the corporation, the directors are relieved of their duties and liabilities, and such duties and liabilities are transferred to the shareholder.^[20]

Finally, the OEB has noted that a shareholder agreement or direction should not limit the board of directors of the regulated LDC from exercising its independent judgment.^[21] 

Conflicts at the Council Level: The MCIA

The Municipal Conflict of Interest Act (“MCIA”) is used to determine the propriety of municipal decision-making, with particular reference to prohibiting involvement of municipal board or council members in matters where such members hold a pecuniary interest (meaning an interest that has monetary or financial value).^[22] This interest may be positive (financial gain), negative (aversion to financial loss), direct, indirect or deemed. Direct interests are those where the impact is immediate (meaning close), while indirect interests are defined as where:^[23]

(a) the member or his or her nominee,

(i) is a shareholder in, or a director or senior officer of, a corporation that does not offer its securities to the public,
(ii) has a controlling interest in or is a director or senior officer of, a corporation that offers its securities to the public, or
(iii) is a member of a body,

that has a pecuniary interest in the matter; or

(b) the member is a partner of a person or is in the employment of a person or body that has a pecuniary interest in the matter.

Deemed interests extend pecuniary interests to parents, spouses or children of members with knowledge of the interest.^[24]

The MCIA contains disclosure and recusal rules for whenever an interest exists.^[25] Thus, in relation to conflicts of interest, the MCIA contains requirements relating to municipal councillors that appear very similar to those contained in the OBCA. In other words, in a situation where a decision or vote arose at a municipal council meeting where the interests of the LDC (or HoldCo) conflicted with those of the municipality, the above MCIA provisions would prima facie force a councillor who is also a director of an LDC (or HoldCo) to recuse themselves.

However, unlike the OBCA, the MCIA contains an exemption to the disclosure and recusal requirements:

[The requirements that a councillor disclose a conflict and recuse themself] do not apply to a pecuniary interest in any matter that a member may have,

…

(h) by reason only of the member being a director or senior officer of a corporation incorporated for the purpose of carrying on business for and on behalf of the municipality or local board or by reason only of the member being a member of a board, commission, or other body as an appointee of a council or local board;^[26]

Thus, a conflict that would force recusal at the HoldCo board level would be exempted at the municipal council level.^[27]

Conclusion

Municipal shareholders use HoldCos to design corporate structures that maximize business synergies across various regulated and unregulated entities while minimizing the overall risk of liability (i.e., taxation, bankruptcy, litigation). However, HoldCos, LDCs and affiliates operate at the intersection of municipal, corporate and regulatory legal regimes, each of which may have significant (and sometimes unexpected) requirements. Good corporate governance in this context remains an ongoing challenge.

[1] Business Corporations Act, RSO 1990, c. B.16, s. 134(1)(a) [OBCA].