Court Disallows Executive's Golden Parachute Benefits

The Ontario Court of Appeal has ruled that a former public company executive is disentitled to receive "golden parachute" benefits under an employment agreement with the corporation as a consequence of the breach of his fiduciary duties.

 

In Unique Broadband Systems, Inc. (Re) 2014 ONCA538, the Court of Appeal reversed the decision of trial judge, Justice R. Mesbur in certain fundamental respects. 

 

Unique Broadband Systems, Inc. (“UBS”) is a public company listed on the TSX Venture Exchange.  In 2002, Gerald McGoey was appointed a director and acting CEO of the company and later became CEO on a permanent basis.  McGoey’s relationship with UBS was governed by a management services agreement between UBS and his personal company.  The agreement contained a “golden parachute provision” which granted McGoey enhanced termination benefits in certain circumstances.

 

UBS had in place an incentive-driven share appreciation rights plan (“SAR Plan”) for its directors and senior management.  Upon certain triggering events, a SAR unit holder would be paid an amount equal to the difference between the market trading price of a UBS share and a strike price identified in the SAR Plan. 

 

In 2003, UBS acquired a controlling equity interest in Look Communications Inc. (“Look”), a telecommunications company.   McGoey was also a director and the CEO of Look.  Look’s primary asset was a band of telecommunications spectrum.  In early 2009, Look engaged in the process of selling the spectrum through a court-supervised plan of arrangement.  Ultimately, the spectrum was sold for $80 million.  McGoey expected that the sale would generate a significantly higher price and was very disappointed with the figure offered by the buyer. 

 

UBS’ board of directors resolved to treat the spectrum sale as a “triggering event” pursuant to the SAR Plan.  Prior to the announcement of the sale, UBS’ shares were trading at approximately $0.15 per share.  The board anticipated that the sale would cause the UBS shares to appreciate however, the anticipated share price increase did not materialize and the shares continued to trade at the $0.15 after the announcement. 

 

McGoey engaged in negotiations to sell the balance of Looks’ assets but the transaction did not materialize. 

 

After the sale of the spectrum, the compensation committee of UBS’ board, which consisted of McGoey and two others, began reviewing the SAR Plan.  Each member of the compensation committee had a considerable number of SAR units. 

 

At a meeting of the board, each director disclosed his conflict of interest regarding their SAR unit holdings.  The directors then unanimously resolved to cancel the SAR units and established a SAR cancellation payment pool of $2.31 million based on a fixed unit price of $0.40 per share.  Under this new arrangement, McGoey and others would receive a SAR cancellation award based on the $0.40 per unit figure. 

 

At a subsequent board meeting, McGoey proposed the establishment of a bonus pool of $7 million.  That proposal was not approved.  However, the board did approve establishing a bonus pool of $3.4 million. 

 

Under the SAR cancellation award, McGoey was allocated to receive $600,000 and under the bonus pool he was allocated to receive $1.2 million.

 

Such awards were resisted by UBS’ shareholders.  Faced with this resistance McGoey caused UBS to advance to him $200,000 for the payment of anticipated legal fees. 

 

At a special shareholders meeting McGoey and the other directors were removed and were not re-elected.  McGoey then resigned as CEO and took the position that he was terminated without cause because he was not re-elected to the UBS board.  McGoey brought an action against UBS seeking payment of enhanced severance in the amount of $9.5 million.  He successfully moved for partial summary judgment before Justice Marrocco. 

 

On July 5, 2011, UBS was granted protection under the Companies’ Creditors Arrangement Act (“CCAA”).  McGoey filed a proof of claim in an amount in excess of $10 million which the CCAA monitor disallowed in its entirety.  The court ordered a trial of the issue. 

 

At trial, Justice Mesbur found that McGoey and the other directors had breached their fiduciary duty to UBS in establishing the SAR cancellation awards and the bonus pool as these actions were driven by the board’s own self-interest and were of no benefit to the UBS shareholders.  She set aside the allocations to McGoey pursuant to the SAR cancellation award and the bonus pool.   However, Justice Mesbur found that the breach of fiduciary duty did not qualify as a default under McGoey’s management services agreement with UBS and that he was therefore entitled to the benefit of the golden parachute provisions of the agreement.  Finally, Justice Mesbur found that UBS had no obligation to indemnify McGoey for his legal fees because he had breached his fiduciary duties. 

 

UBS appealed and McGoey cross-appealed.

 

The Court of Appeal held that UBS’ appeal should be allowed and McGoey’s cross-appeal should be dismissed.

 

Justice Hourigan wrote the decision of the Court of Appeal.

 

The Court of Appeal held that Justice Mesbur had reasonably concluded that the board’s actions were driven by self-interest and therefore that McGoey had breached his fiduciary duties to UBS.  The $0.40 share price was unjustified and unrealistic.  The board did not seek any expert advice on an appropriate bonus structure and did not have any comparable or other data regarding executive compensation in the marketplace.

 

The Court of Appeal also found that there was no documentation that stipulated the performance factors or criteria by which McGoey’s performance would be evaluated, and there was no documentation that showed how the bonus pool was quantified.  The breach was not incomplete because McGoey was removed from office before he could be paid.  The court held that it would be a remarkable result if a fiduciary could be allowed to act in a manner contrary to his duty with impunity on the basis that he was prevented by the beneficiaries' vigilance from receiving a personal benefit.

 

The Court of Appeal held that McGoey’s actions were not undertaken with the assistance of independent legal advice.  His actions were not protected by the business judgment rule as he did not satisfy the rules' preconditions of honesty, prudence, good-faith and a reasonable belief that his actions were in the best interests of the company.  Accordingly, because McGoey had breached his fiduciary obligations, UBS was not required to indemnify him for his legal fees.

 

The Court of Appeal disagreed with Justice Mesbur’s interpretation of the management services agreement.  It held that her interpretation had ignored section 134(3) of the Ontario Business Corporations Act (“OBCA”) which provides that no provision in a contract relieves a director or officer from the duty to act in accordance with the OBCA or from his or her liability for a breach thereof.  The Court of Appeal held that Justice Mesbur’s interpretation had led to a commercially absurd result.  Interpreting the provisions of the agreement which defined a "default" which would disentitle McGoey to an enhanced severance payment as including a serious breach of fiduciary duty that was materially injurious to UBS would give effect to the entirety of the words used in the definition in their context.  Such an interpretation was also commercially sensible and was not inconsistent with the OBCA.

Regards,

Blair

Ontario Court of Appeal Stays Securities Class Action

In a recent discussion (Kaynes v. BP, PLC 2014 ONCA 580), the Ontario Court of Appeal stayed a proposed class action against BP, PLC for secondary market misrepresentation on the principle of forum non conveniens.  The Court concluded that while Ontario Courts had jurisdiction to hear the class action, there was another forum that was clearly more appropriate for the adjudication of the plaintiff's claim and of the claims of foreign exchange purchasers of BP's securities.

 

The plaintiff's claim rose out of the Deep Water Horizon oil spill that occurred in the Gulf of Mexico in April of 2010.  The plaintiff alleged that BP made certain misrepresentations in its public disclosures, before and after the spill, related to its operations, safety programs, and the accident that impacted the price of BP's shares.  His claim was based on part XXIII.1 of the Ontario Securities Act which provides a statutory cause of action for secondary market misrepresentation.

 

The plaintiff, a resident of Ontario, purchased his shares over the New York Stock Exchange. The proposed class included all residents of Canada who acquired BP securities between relevant dates wherever those securities were purchased.

 

BP's challenge of Ontario's jurisdiction to hear the class action was dismissed by a motion Judge.  BP appealed that decision to the Court of Appeal.  The Court of Appeal agreed with the motion judge that Ontario did have jurisdiction simpliciter, but concluded that the motion Judge had erred in principle in failing to decline jurisdiction on the basis of forum non conveniens.

 

The Court of Appeal held that there was a real and substantial connection between BP, or the subject matter of the claim and the forum despite the fact that BP was a UK corporation headquartered in London, England and did not own any real or personal property in Canada, nor did it carry on business in Canada.  BP's common shares were listed for trading on the London Stock Exchange, the Frankfurt Stock Exchange and the New York Stock Exchange.  They had never been listed on the Toronto Stock Exchange.

 

However, BP was a "reporting issuer" under Ontario securities regulations when the plaintiff purchased what is known as American Depository Shares ("ADS") a form of equity security currently listed for trading only on the New York Stock Exchange.  BP was a reporting issuer during the period when ADS were traded on the TSX.  In 2009 after ADS were delisted from the TSX, BP ceased to be a reporting issuer in Ontario and other Canadian provinces on the undertaking that it would continue to send relevant investor documents to its shareholders in Canada.

 

BP did not dispute that it was required by the undertaking send the plaintiff the documents that contained the alleged misrepresentations.  The Court of Appeal held that when BP released the documents, BP knew by virtue of the undertaking it had given that even if the initial point of release was outside Ontario, the documents were "certain to find (their) way to Ontario and to its Ontario shareholders".  Accordingly, by releasing such documents, BP committed an act that had an immediate and direct connection with Ontario.  That was sufficient to establish a real and substantial connection between the claim and Ontario.

 

Accordingly, the Court of Appeal agreed with the motion judge that such connection was a presumptive connecting factor for a tort committed in Ontario and therefore there was jurisdiction simpliciter in Ontario.

 

However the Court of Appeal indicated that a court has discretion to decline to exercise its jurisdiction under the forum non conveniens doctrine if the defendant showed that another forum was clearly more appropriate for the adjudication of the action.

 

In this case, BP argued that Ontario should decline jurisdiction in favour of the United States and the United Kingdom.   Laws of both countries related to jurisdiction over such claims was based on the principle that securities litigation should take place in forum where the securities transaction took place.  Their approach to jurisdiction over securities litigation was based principle of comity.

 

The Court of Appeal held that the motion Judge had erred in failing to take to account the principle of comity and erred in law with respect to a related issue of avoiding a multiplicity proceedings.

 

Both the US and the UK reserved jurisdiction on the basis of the location of stock exchange where the securities are traded. US law goes one step further and provides for the exclusive jurisdiction of the US courts over such claims. In keeping with the principle of comity, the court is obliged to consider that claim of exclusive jurisdiction.  The Court of Appeal  held that asserting Ontario's jurisdiction over the plaintiff's claim would be inconsistent with the approach taken under both US and UK law with respect jurisdiction over claims for secondary market misrepresentation. The principle of comity strongly favoured declining jurisdiction. 

In addition, avoiding a multiplicity of proceedings means that what should be avoided is litigation in more than one jurisdiction over the same claims of the same parties. Proposed class parties who have not opted out of the US proceedings would be problematic in that regard.

As a result, the Court stayed the proposed class proceeding.

Regards,

Blair

Ontario Securities Commission Rejects Insider Trading Allegations

The Ontario Securities Commission (“OSC”) released its long awaited decision in the Baffinland insider trading case.  Hearings in the case began in January of  2013 and concluded in September of that year.  The decision was a disappointment to observers who have been clamouring for stiffer penalties for violation  of securities regulations as the OSC dismissed all allegations of wrongdoing against the respondents.

 

In its statement of allegations, staff of the OSC (“Staff”) made allegations of insider trading, tipping and conduct contrary to the public interest in connection with the purchase of 20 million common shares and 5 million warrants of Baffinland Iron Mines Corporation by Nunavut Iron Ore Acquisition Inc., a company owned and controlled by Jowdat Waheed and Bruce Walter.  Nunavut Iron Ore acquired a “toehold” purchase of Baffinland on September 9, 2010 and launched a hostile takeover bid for Baffinland on September 22, 2010.

 

At the time, Baffinland was a publicly-traded junior mining company focused on developing iron ore deposits on its Mary River property located on Baffin Island in Nunavut. 

 

In February of 2010, Waheed entered into a consulting agreement with Baffinland to provide strategic advice to its board of directors and CEO with respect to potential partnerships, mergers and raising capital for the Mary River project.  Waheed ceased to provide those services in  April of 2010. 

 

In July 2010, Waheed approached Walter about a potential transaction involving Baffinland.  Discussions between them progressed over the summer and ultimately resulted in the launch of the takeover bid.  Waheed and Walter incorporated Nunavut Iron Ore in August of 2010.  Walter was the Chairman and Waheed was the President of Nunavut Iron Ore. 

 

Staff alleged that:

a)  both Waheed and Walter authorized, permitted or acquiesced in the toehold purchase (i.e. the purchase of a significant block of shares in Baffinland) while they were in a special relationship with Baffinland and while they had knowledge of material facts with respect to Baffinland that had not been generally disclosed;

 

b)  Waheed, while in a special relationship with Baffinland, informed third parties including Walter of material facts of Baffinland before the material facts were generally disclosed and that both Waheed and Walter had used material facts and confidential information belonging to Baffinland to make the toehold purchase and launch the takeover bid contrary to the public interest; and

 

c)  Waheed had acted contrary to the public interest by not always acting in Baffinland’s best interest while he was a consultant and afterwards.

 

After over 40 days of evidence and submissions in which over 2,600 documents were filed, the OSC dismissed Staff’s allegations finding that the respondents did not trade or tip in respect of undisclosed material facts.  The OSC held that at the time of the toehold purchase, Waheed did not have knowledge of material facts about Baffinland that were not generally disclosed.  In addition, the OSC concluded that there was no other conduct by Waheed and Walter that warranted the exercise the OSC’s public interest jurisdiction.  

 

The statutory framework for insider trading is found in subsection 76(1) of the Ontario Securities Act (“Act”).   That subsection provides that no person or company in a special relationship with a "reporting issuer" shall purchase or sell securities of the reporting issuer with the knowledge of a material fact or material change with respect to the reporting issuer that has not been generally disclosed.  

 

Baffinland’s only mining asset was the Mary River property on which high grade iron ore deposits are located.  The property is approximately 100 km south of the northern coast of Baffin Island which is north of the Arctic Circle.  Two individuals gained a controlling interest in Baffinland Iron Mines Ltd., the private company that held the Mary River Project in 2002 and took it public through a reverse takeover in 2004.  Baffinland reactivated exploration work on the project that had been dormant for some time and by January 2008 had spent over $150 million.

 

In March 2008, Baffinland completed a $193 million public equity offering for the stated purpose of further exploration and development activities and for general corporate purposes.  In 2008, Baffinland initiated a process to identify a strategic partner (or partners) that would assist in financing the Mary River project.  It engaged CIBC and CitiGroup Global Markets Inc. to act as its co-financial advisors.  Baffinland entered into a number of confidentiality agreements with companies in 2008.  In 2009, it appointed a strategic committee to oversee its strategic partnering activities .  It entered into the consulting agreement with Waheed subsequently.  

 

The commission found that as a consultant, Waheed had access to information about a potential transaction between Baffinland and ArcelorMittal, a large steel and mining company.  However, given the status of negotiations between Baffinland and  ArcelorMittal, the information that Waheed had was stale and was not material by the time the toehold purchase was made.  Therefore, the insider trader and tipping allegations failed.

Because at the time of the toehold purchase, Waheed did not have knowledge of material facts about Baffinland that were not generally disclosed, it followed that he did not convey any such material, non-disclosed facts to Walter. 

 

The commission held that an assessment of materiality is fact-specific and will vary with every issuer according to multiple facts.  The test to be applied when determining whether any fact is a material fact is an objective market impact test set out in the definition of material fact in subsection 1(1) of the Act.  In this case, that would require that the OSC determine if any of the alleged material facts would reasonably be expected to significantly affect the market price or value of Baffinland’s securities. 

 

With respect to its public interest jurisdiction, the OSC held that  two aspects of the public interest jurisdiction are of particular importance as found in the purposes of the Act, i.e. to provide protection to investors from unfair, improper or fraudulent practices and to foster fair and efficient capital markets and confidence in capital markets. 

 

The OSC concluded that its public interest jurisdiction was not invoked by the respondents’ conduct.  Although Waheed was in a special relationship with Baffinland as a result of his consultancy, he was not a director or officer of Baffinland or a registrant.  Consequently, the OSC was not required  to exercise its public interest jurisdiction to ensure honest and responsible conduct by market participants.

 

The OSC found that toehold purchases are excluded from the prohibition against insider trading and acknowledged that the acquisition of toeholds is a permitted strategy for bidders.  Absent insider trading or tipping, there was  nothing in the respondents’ toehold purchaser takeover bid that was contrary to the public interest.

Regards,

Blair