Canada: Supreme Court Of Canada Refuses Leave In Look Communications Inc. Case On Advancement Of Defence Costs

Last Updated: March 6 2014
Article by Don McGarvey, Q.C.

The Supreme Court of Canada recently refused leave to appeal the latest Canadian decision of significance on the advancement of defence costs to directors and officers.

In Cytrynbaum et al v. Look Communications Inc., 2013 ONCA 455 (CanLII) the Ontario Court of Appeal refused a request of certain directors and officers who had been sued for what was alleged to have been improper conduct on the part of the directors and officers that put them into receipt of substantial monetary benefits.

Look Communications Inc. ("Look") had been incorporated pursuant to the Canadian Business Corporations Act and was engaged in the wireless, internet and cable services industry. As an incentive to its directors, officers, employees and consultants, Look adopted a Share Appreciation Rights Plan ("SARs Plan") allowing share appreciation rights based upon the market value of Look's shares. The SARs could be exercised if Look sold all or substantially all of its assets, whereupon the holder of the SARs would be entitled to be paid the difference between the market price of the shares on that date and the price of the shares on the dates the SARs were granted.

From 2005 to 2008, Look's business began to decline and by late 2008, the board was seeking to sell Look's assets pursuant to a plan of arrangement under the supervision of a monitor. Ultimately, the sale was achieved in early 2009 when the company's key assets were sold for $80 million, less $16 million to be paid to settle certain outstanding litigation. Ultimately, the sale was approved both by the shareholders and by the court.

The board also approved a recommendation to set aside $11 million for severance, retention and bonus payments while also agreeing to terminate the SARs and cancel all share options on the basis of a share valuation of $0.40 per share. This was contrary to both the terms of the SARs and the option plans which specified that market value was to be used. At the time, the true market value of the shares was $0.20 rather than $0.40.

Of the more than $20 million generated as net sale proceeds of Look's assets, the directors, officers, employees and consultants received 32% by way of bonuses and equity cancellation payments.

Naturally, this attracted a great deal of shareholder interest and concern and ultimately, in anticipation they would be sued, the directors and officers authorized Look to pay $1.55 million as retainers to three law firms who would act for them personally in any actions commenced as a result of these payments.

In denying the claim of the directors and officers for an advancement of defence costs to defend the litigation by the shareholders, the Court focused on the indemnity and "advancement of expenses" provisions in Look's by-laws. Section 124 of the Canadian Business Corporations Act was also analyzed as to indemnification rights and advancement of defence costs.

The Application Judge, in the first instance, found that, actions which have no merit should not delay advancement [of defence costs]. On the other hand, directors or officers who have engaged in wrongful conduct towards the corporation ought not to be allowed to use corporate funds to defend themselves. He found that section 124 of the Canadian Business Corporations Act is a complete code as to indemnity and advancement [of defence costs] rights.

More importantly, both the Application Judge and the Court of Appeal found that while directors and officers are entitled to the benefit of a presumption of good faith, that presumption was rebuttable, if a strong prima facia case could be established. If so established, it would remove the entitlement to advancement of defence costs.

The Court of Appeal affirmed that Look had made a strong prima facia case that the directors and officers had acted in bad faith by using a share value of $0.40 per share when the actual market value was $0.20 per share. The $0.40 per share price had no relationship to market value, was contrary to the terms of the SARs and the option plans and was not determined in consultation with an outside expert such as an actuary or valuation expert. The result was that it conferred personal benefits on the directors and officers of approximately $9 million largely at the expense of the corporation.

Furthermore, the Court noted that the retainer payments to the three law firms were made contemporaneously with these payments having been received.

This resulted in three significant findings:

1. The entitlement of directors and officers to an advancement of defence costs must be decided on the basis of the overriding language of section 124(4) of the Canadian Business Corporations Act and with reference to the by-laws of the corporation. Advancement of defence costs should only occur where the directors and officers have acted honestly and in good faith with a view to the best interests of the corporation. They are presumed to have acted in that fashion.

2. By its very nature, a request for advance funding invites a preliminary assessment of the merits of the case. Any such assessment is indeed preliminary and does not bind the parties for the purpose of the underlying action.

3. While the directors and officers are entitled to the presumption of good faith as directors and officers, the corporation can lead evidence to rebut that presumption. If there is a strong prima facia case demonstrating bad faith on the part of the directors and officers, the advancement of defence costs will be denied. The strong prima facia case test strikes a balance between providing adequate protections against improper conduct by directors and officers and providing incentive to the company to attract strong candidates who foster entrepreneurialism and encourage responsible behaviour.

Given that the Supreme Court of Canada very recently refused to hear the appeal of the directors and officers, the Look Communications decision may well be heavily relied upon as the seminal case on advancement of defence costs across Canada.

Of course, there may also be considerations flowing from a directors and officers liability policy that may impact on decisions of this nature. Therefore, each case should be reviewed based upon its own facts including the precise wording of the by-laws of the corporation and any directors and officers liability policy. That said, the language in the legislation appears clear and the requirement for directors and officers to always to act in the best interest of the corporation will remain sacrosanct.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Don McGarvey, Q.C.
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