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 Appeal Court Dismisses Class Action Against Manulife For Pure Economic Loss

The Ontario Court of Appeal has affirmed a trial judge's decision to dismiss a class action against the Manufacturers Life Insurance Company (“Manulife”) on the basis that there was no cause of action for the plaintiffs' pure economic loss.

 

In Mandeville v. The Manufacturers Life Insurance Company, 2014 ONCA 417, the appeal court considered whether Manulife owed a novel duty of care to certain policyholders in connection with its decision to "demutualize" the company.  
 

As a mutual insurance company, Manulife was governed by the Insurance Company’s Act (the “Act”).  The Act required Manulife to obtain regulatory approval for the transfer (i.e., the demutualization) from the Canadian government.  Because the “block of business” in issue was located in Barbados, Manulife also needed the approval of the Barbados government.

 

Approximately 8,000 residents of Barbados had participating policies with Manulife that were transferred to the Barbados Insurance Company.  In demutualizing, Manulife converted from a mutual insurance company to a stock company.  Because the class members policies had been transferred to the Barbados Insurance Company, they were no longer Manulife participating policyholders and therefore were ineligible to share in the value of the company.

 

The class action brought by the Barbados policyholders claimed that Manulife was negligent and breached its fiduciary duty that it owed to them.  Their negligence claim was founded on the allegation that Manulife knew it was going to demutualize when it transferred its Barbados business and that it ought to have structured the transfer in a way that protected or preserved the class numbers’ rights to share in the value of Manulife on demutualization.  They sought damages equal to the amount that the class members would have received had they been treated as eligible policyholders on demutualization.

 

After a 29 day common issues trial, Justice Newbould of the Ontario Superior Court concluded that while Manulife owed the Barbados policyholders a prima facie duty of care based on foreseeability of harm and proximity, for policy reasons, he refused to recognize that duty of care.  Had he found Manulife liable, Justice Newbould would have ordered Manulife to pay damages of approximately $82 million, plus interest.

 

The class members advanced an alternative theory that claimed that Manulife should have compensated them for the loss of their “ownership rights” at the time of the transfer.  Justice Newbould also rejected this theory, but determined that if liability had been established on that basis, he would have ordered Manulife to pay damages of $24.5 million, plus interest.

 

The class members appealed to the Court of Appeal.  Manulife cross-appealed on the issue of damages.  Justice Gillese writing for the Court of Appeal (Justices Blair and Strathy) held that the appeal and the cross-appeal should be dismissed.

 

In coming to the appeal court’s decision, Justice Gillese reviewed the key concepts in play about how a mutual insurance company was established and how it demutualized.  She then set out a brief history of demutualization in Canada beginning in the late 1950’s when insurance companies in Canada became concerned about their vulnerability to hostile takeovers, the enactment by Parliament of amendments to the Canadian and British Insurance Companies Act (predecessor to the Act) to allow stock companies to mutualize and ending in the 1990’s when insurance companies began to see the advantages of converting back into stock companies. 

 

In 1990, Manulife decided to sell its life insurance in the Caribbean – Atlantic region because the business was too small to operate effectively and its growth prospects were poor.  Manulife eventually sold all of its business in the Caribbean, except for the business in Barbados.  In Barbados, an insurance company required approval of the Supervisor of Insurance in order to transfer all or part of its business to another company.  Justice Gillese explained in detail Manulife’s attempts to transfer its Barbados business.  It was finally able to reach an agreement to do so in 1996.  Manulife obtained regulatory approval to close the sale and transfer its Barbados policies from both the Canadian and Barbados regulators.  Manulife’s demutualization became effective approximately 3 years later, in September of 1999.

 

In 2002, the proceeding was certified as a class action by Justice Nordheimer.  Justice Nordheimer concluded that the regulatory approval given by Barbados Government did not automatically bar the Barbados policyholders from bringing the action.

 

Ten years after certification, the matter was brought to a common issues trial.

 

After reviewing the findings made by the trial judge, the Court of Appeal held that the appeal raised a single issue:  Did the trial judge err in refusing to recognize that Manulife owed the class members a duty of care at the time of the transfer?

 

The Court held that the nature of the appellants’ claim was not straightforward in this case.  Justice Gillese wrote that the question wasn’t whether the participating policyholders could be described as owners of a mutual insurance company.  It was whether at the time of the transfer to the Barbados Insurance Company, whether the class members had a legally recognized right or interest in respect of a possible demutualization by Manulife.  She held that they did not.  At the time of the transfer in 1996, mutual companies like Manulife were not permitted to demutualize.  That right only came into existence in 1999.  The terms of the class members’ policies did not refer to any right to receive benefits on demutualization.  In addition, there was no such right afforded by statute or regulation.  Because Manulife had no right to demutualize in 1996, the appellants could have had no right to share in the benefits of demutualization.

 

Justice Gillese concluded that a hope or mere expectancy is not illegally enforceable right or interest.

 

In addition, the Court of Appeal held that the appellants’ claim was one for pure economic loss.  Pure economic loss is loss suffered by an individual that is not accompanied by physical injury or property damage.  Damages claimed by the appellants is equivalent to the benefits the class members would have received had they been treated as eligible policyholders upon Manulife’s demutualization.  The damages are not causally connected to physical injury to their persons or physical damage to their property.

 

When a claim is made for pure economic loss, the Supreme Court of Canada in Martel Building Ltd. v. Canada, 2000 has held that such claims or require greater scrutiny when the court is deciding whether to recognize a duty of care.  The Supreme Court of Canada in Martel set out the policy reasons underlying the common law's traditional reluctance to permit recovery for pure economic loss:

 

            “First, economic interests are viewed as less compelling of protection than bodily security or proprietary interests.  Secondly, unbridled recognition of economic loss raises the spectre of indeterminate liability.  Third, economic losses often arise in a commercial context, where they are often an inherent business risk best guarded against by the party in whom they fall through such means as insurance.  Finally, allowing the recovery of economic loss through tort has been seen to encourage a multiplicity of inappropriate law suits.  

 

However, Canadian jurisprudence shows that there was no automatic bar to recovery for pure economic loss.

 

Justice Gillese utilized the test established in Anns v Merton Borough Council  to determine whether a novel duty of care between a mutual insurance company and its participating policyholders should be recognized in the present case.  Anns is a 2 stage test for determining whether a duty of care arises - i.e., 1) was the harm that occurred, the reasonably foreseeable consequence of the Defendant’s Act; and 2) are there reasons, notwithstanding the proximity between the parties that tort liability should not be recognized?

 

Applying the Anns test, the Court of Appeal agreed with Justice Newbould that the harm the class members suffered was a reasonably foreseeable consequence of Manulife’s transfer of their policies.  However, the appeal judges disagreed that a prima facie duty of care had been established.  They concluded that given the tenuous and inchoate nature of the interest that the policyholders sought to have protected, the proximity requirement had not been satisfied and a prima facie duty of care did not arise.

 

Having found no prima facie duty of care at the first stage of the Anns test, the Court held that it was unnecessary to continue the second stage and consider whether there were residual policy considerations that would negate the imposition of a new duty of care.  Despite that finding, Justice Gillese held that there were two policy considerations that precluded a duty of care -  the spectre of indeterminate liability and a multiplicity of inappropriate law suits. 


The court dismissed the policyholders' appeal.


Regards,


Blair 

 

Supreme Court clarifies ad hoc fiduciary relationships

In the recent case of Galambos v. Perez, P made voluntary sizeable advances of cash — some $200,000 in total — to her employer, a law firm founded by G, often without informing G beforehand. Although P was hired as the firm’s part‑time bookkeeper she effectively became the office manager, overseeing the firm’s income, expenses and accounting and had unlimited signing authority on the firm’s non‑trust bank accounts. Initially, to resolve a cash flow problem, P obtained a personal loan and deposited $40,000 into the firm’s bank account. G did not ask her to advance this money and he did not even know about the advance until several days later. G instructed P to reimburse herself with interest, instructions she did not follow other than by repaying herself $15,000. As the firm’s financial situation deteriorated, P made several more deposits of her own funds into the firm’s account and covered some firm expenses with her personal credit card. The firm, during the time she worked for it, handled the preparation and execution of new wills for P and her husband as well as two mortgage transactions. The firm did not expect to be and was not paid for these services. When the firm went into receivership and G went bankrupt P found herself an unsecured creditor and recovered nothing. P then sued G and the defunct firm for negligence, breach of contract and breach of fiduciary duty.

The trial judge dismissed P’s claims, finding that her rights were those of a creditor and nothing more. The Court of Appeal set aside that decision and granted P judgment for $200,000. The Court of Appeal concluded that there were ad hoc fiduciary duties owed to P by G and his law firm in relation to the cash advances. It held that: there was a power‑dependency relationship between P and G; it is not necessary that there be any mutual understanding that G had relinquished his self‑interest in favour of P’s for the duty to arise; P was vulnerable; and, the evidence overwhelmingly supported the conclusion that G took advantage of her trust.

The Supreme Court of Canada restored the decision of the trial judge and held that the Court of Appeal had exceeded the limits of appellate review and unduly extended the scope of fiduciary obligations. Absent an error of law or a palpable or overriding error of fact the SCC held that the trial judge’s findings of fact and conclusion that a fiduciary duty did not exist must be upheld on appeal. In this case, the Court of Appeal retried the case on the basis of the written record and substituted its view of the facts and their significance for that of the trial judge.

The SCC held that the Court of Appeal erred in three respects.

1. The conclusion that G was in a position of power and influence relative to P was at odds with the findings of fact at trial that P was not vulnerable in terms of her relationship with G. There was no evidence of any express requests for loans, which makes it illogical to conclude that P was unable to refuse requests when there were in fact none.

2. Not all power‑dependency relationships are fiduciary in nature and identifying a power‑dependency relationship does not, on its own, materially assist in deciding whether the relationship is fiduciary or not. There are no special rules for recognition of fiduciary duties in the case of power‑dependency relationships. The Court of Appeal erred when it held that, in the case of a power‑dependency relationship, a fiduciary duty may arise even in the absence of a mutual understanding that one party would act only in the interests of the other. In both per se and ad hoc fiduciary relationships, there will be some undertaking on the part of the fiduciary to act with loyalty. The Court of Appeal’s analysis went wrong when it found a fiduciary duty without finding an undertaking, express or implied, on the part of G that he would act in relation to the loans only in P’s interests, and based its conclusion that a fiduciary duty existed on P’s expectations alone.

3. The Court of Appeal appears to have accepted the proposition that a fiduciary duty may arise even though the fiduciary has no discretionary power to affect the other party’s legal or important practical interests. The nature of this discretionary power to affect the beneficiary’s legal or practical interests may, depending on the circumstances, be quite broadly defined. It may arise from power conferred by statute, agreement, from a unilateral undertaking or, in particular situations by the beneficiary’s entrusting the fiduciary with information or seeking advice in circumstances that confer a source of power. The presence of this sort of power will not necessarily on its own support the existence of an ad hoc fiduciary duty; its absence, however, negates the existence of such a duty. The findings of the trial judge that the evidence did not establish that P relinquished her decision‑making power with respect to the loans to G, and that G had no discretionary power over P’s interests that he was able to exercise unilaterally or otherwise, were fatal to P’s claim that there was an ad hoc fiduciary duty on G’s part to act solely in her interests in relation to these cash advances.

Finally, the SCC held there had been no conflict of interest. Given the limited nature of the retainers and the unusual nature of the advances G and the law firm did not breach their duty of care arising from the solicitor‑client relationship between them and P. There was no actual conflict of interest between the firm’s duties to her in connection with the limited retainers and its interest in receiving the advances and there was not any reasonable apprehension of conflict. Given the very limited nature of the retainers and the manner in which the advances were made — unsolicited and frequently without advance notice — there was no duty on the firm under negligence principles to give P advice about those advances or to insist that she obtain independent legal advice about them.

Regards,

Blair

Departing Employees owe duties to Employers

The Supreme Court of Canada has sent a strong message to a group of employees who orchestrated their departure from their employer, resulting in serious harm to the employer's economic interests.

A recent decision released by the Court involved RBC Dominion Securities and Merrill Lynch Canada, competitors in the investment brokerage business. In a move coordinated by RBC's branch manager, virtually all of the investment advisers at RBC left their jobs and went to work for Merrill Lynch. As a result of the departure, only two very junior investment advisors , who Merrill Lynch had not sought to recruit, and two administrative staff members remained at the RBC branch. The employees gave RBC no advance notice and in the weeks preceding their departure they copied RBC's client records and transferred them to Merrill Lynch. The Court found that RBC's office was effectively hollowed out and all but collapsed.

In a 6 to 1 ruling, the Supreme Court restored a trial award of $225,000 against Merrill Lynch, and its manager which were held jointly and severally liable for inducing the breach of the employees' contracts and for unfair competition, as well as $250,000 in punitive damages against Merrill Lynch. The Merrill Lynch manager was individually found liable for punitive damages in the sum of $10,000.

The court awarded $40,000 total damages to RBC against its former employees for failing to give RBC adequate notice of their departure as well as punitive damages of $5,000 each. It awarded over $1.4 million against the former RBC branch manager who had orchestrated the operation for breaching his duty of good faith and $5,000 in punitive damages. The damage award represented five years of lost profits for RBC.

The Court found that damages arising in respect of a breach of contract should arise either naturally, or as reasonably contemplated by both parties at the time they made the contract. In organizing the mass exit, RBC's manager breached his contractual duty of good faith, as an implied term of his employment contract was the retention of RBC employees who were under his supervision. The damages for that breach were the amount of loss it caused to RBC.

Generally individual employees who terminated employment are not prevented from competing with the employer during the notice period. The employer is confined to damages for failure to give reasonable notice. However, a departing employee might be liable for specific wrongs, such as improper use of confidential information during the notice period.

This case is an important one for employees who are concerned about whether they may really be found liable for damages for failing to provide reasonable notice of their departure and the fiduciary obligations of managerial employees and employers who consider hiring employees away from their competitors.

Regards,

Blair