More stakeholders, more scrutiny

Corporate directors must consider both multiple stakeholders and multiple challenges: from activist shareholders to environmental, social and governance issues to the oversight of corporate conduct in the wake of #MeToo

In early January, Coastal GasLink contractors hired to construct a natural-gas pipeline in central British Columbia were forced to vacate the worksite near Houston, B.C. after an “eviction notice” was issued by hereditary chiefs of the Wet'suwet’en First Nation and felled trees made the road impassable.
Coastal GasLink had engaged in community consultations, including with First Nations, since 2012, and had signed agreements with all 20 elected First Nations councils along the pipeline’s route. On Dec. 31, 2019, the company was granted an injunction by a B.C. Supreme Court judge against protestors who had blocked access to the project inside their territory; yet its work was halted regardless.

This is an example of the kind of issue with which Canadian corporations and their boards of directors must increasingly deal, and it’s one of many that must be considered in an era of multiple stakeholders, as well as increased scrutiny and expectations.

“You wouldn’t have seen this [issue arise] even five years ago,” says Grant Zawalsky, managing partner of Burnet Duckworth Palmer LLP in Calgary, who works largely in the energy sector, including in corporate governance and shareholder activism. “Five years ago, you would see general protests, but they weren’t targeted against specific projects,” he adds.

"I think that . . . shareholder engagement, ESG [environmental, social and governance] and oversight of corporate conduct are three very big topics that boards will have to deal with in 2020.”

Cornell Wright, who chairs Torys LLP’s corporate department from his office in Toronto, points to a “variety of competing pressures” facing directors and their corporations today.

“You have increasingly vocal and activist shareholders who are, in many cases, focused on short-term shareholder value maximization. And, at the same time, you have a variety of other stakeholder groups who are focused on ESG, are focused on issues of . . . inequality as it relates to employees,” says Wright.

“You have a range of competing concerns, and directors in companies find themselves in difficult positions,” he says. “And you see that play out in the context of a range of issues, both transactions, but also of general concern.”

Activist investors

Since 2008, when the Supreme Court of Canada issued its decision in BCE Inc. v. 1976 Debentureholders, boards of directors must be mindful of the interests of all stakeholders, and not only shareholders.

However, although there is no “shareholder primacy over other stakeholders,” says Alex Moore, an M&A lawyer and partner at Blake Cassels & Graydon LLP in Toronto, whose practice includes corporate governance, “the reality is that directors are annually accountable to the shareholders for the job that they’re doing; if shareholders don’t like the job that the directors are doing, they can withhold their votes from those directors to force a resignation” if the company is performing poorly, “or the shareholders, if it's an activist situation, can even propose their own directors for election.

“Ultimately, it's the shareholders who make the decision on board composition.”

Moore says a trend among corporate directors in the past five or so years is a heightened awareness of the potential for activism, as well as boards being “receptive to engaging in a constructive way with shareholders.”

At the same time, says Wright, a board must ask itself if it is well served relying only on the activist investors’ perspective or whether it should seek outside advice from financial professionals and others.

In an activist fight, “the board is meant to be leading,” Wright says. “They need to make sure they’re equipped with the thinking they need,” independent of internal management.

Shareholder engagement

The “big sea change in the boardroom” in the past five to 10 years has been the extent of engagement by shareholders, says Patricia Olasker, a partner at Davies Ward Phillips & Vineberg LLP in Toronto, whose corporate law practice includes shareholder activism. In fact, she says, “What we are most frequently asked to advise boards on is how to deal with that situation.”

Today, this engagement is less with aggressive activists demanding changes, but it takes the form of “ever-present input into decision-making by sophisticated institutional shareholders that have large stakes in the business,” she says. Boards are having to engage with their shareholders routinely, not just when there’s a crisis.

The best boards out there will routinely “sit down with the top shareholders and listen more than talk,” she says. “It’s engaging the shareholders to get their view on issues.”

More companies also provide “a more transparent guidebook” for shareholders, allowing the board and management to provide their perspective to shareholders, says Moore.

About half of TSX-listed companies have voluntarily moved to say on pay for shareholders, meaning shareholder input into what executives earn, he says. “So, we may see increasing adoption” in larger companies, he says.

Pay ratio disclosure — i.e., disclosing the difference in salary between executives and average workers in a company — has gained popularity in the United States. The Securities Exchange Commission has adopted pay ratio disclosure for publicly traded companies, and the first disclosures were made in 2018, says Moore.

The SEC ended up adopting flexible rules that give companies a fair bit of discretion in how they determine the median worker, Moore says. And the U.K. has adopted a rule that will require publication of CEO-worker pay ratios for the 2019 year during the 2020 annual meeting season. Still, he adds, “I haven’t seen in my own practice a widespread push for that sort of global transparency” on pay ratio disclosure, for which there are yet no such requirements in Canada.

Environmental, social and governance

Although Warren Buffet may take the view that companies shouldn’t invest their shareholders’ cash to social causes and should focus instead on what would most benefit those shareholders, many investors are nonetheless focused today on ESG principles, says Torys’ Wright.

“It’s a difficult dynamic,” Wright says, “because . . . it’s hard to argue with initiatives that would support long-term sustainability” and those impacts on various employee and stakeholder groups. But “it comes down to the board’s responsibility to think of the long-term best interests of the company; it’s not sustainability in itself. What companies are focused on is ‘what’s our plan?’”

Who decides which First Nations individuals or groups should have authority to approve resource projects and more must ultimately be dealt with by the Supreme Court of Canada, says Zawalsky. He calls the Coastal GasLink situation “very interesting from a legal point of view,” because the group protesting the pipeline project are hereditary chiefs and not elected band council members; i.e., they are chiefs by blood lineage rather than election.

"TC Energy has agreements with all of the First Nations councils on its route,” he says. “The issue is who properly speaks for First Nations? Who has governance over unsurrendered rights of First Nations? . . . Who do you [especially energy companies] need to consult with . . . depending on the issue?”

Oversight of corporate conduct

In the age of #MeToo and heightened scrutiny of workplace social conduct, “oversight of corporate conduct is becoming a big issue,” says Zawalsky.

More generally, there’s an expectation that a board will supervise conduct in the C-suite, whether that’s regulatory compliance or sexual misconduct, says Olasker. “There’s an expectation that the board will be accountable, certainly reputationally even if not legally.” In regulated sectors especially, such as cannabis, boards need to be informed in order to make appropriate inquiries, she says.

One high-profile example of the consequences of a workplace romantic relationship between employees of disparate levels of authority was when McDonald’s CEO Steve Easterbrook, credited with modernizing the corporation and nearly doubling its share price during his tenure, lost his job in November for dating a subordinate, in violation of company policy.

“Has the pendulum swung so far that boards are overreacting, or have social mores changed so much” that any dating in the workplace, even consensual, is considered inappropriate? Olasker asks. “I think most boards will land on the side of taking a harsher stance on the conduct rather than risk being criticized for laxity in the public view.”

Board independence and advice

A committee of independent directors should be established at the first sign of trouble, says Olasker, and securities regulators expect it, she notes, citing the Ontario Securities Commission’s decision on the Catalyst Group’s and Baker bids to purchase the Hudson’s Bay Company. HBC chairman Richard Baker had led a bid on behalf of a group of majority shareholders to buy the company, but the Catalyst Group Inc., a private equity firm also bidding, complained of the timing and quality of the bidding process, notably that HBC had not properly informed shareholders of important details of the bid.

In December, the OSC decided to delay the shareholder vote, and it will require a great deal of additional information now, says Olasker.

“It was a really powerful reminder to boards that they've got to do more than go through the motions in conflict transactions,” she says. “They've really got to have a robust process.”