Monday, September 29, 2014

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

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