Canada: Pay Me Now: Court Of Appeal Delivers Lessons On Fiduciary Duties, The Business Judgment Rule, And Executive Compensation

The business judgment of directors setting executive compensation was front and centre in the Ontario Court of Appeal's recent decision in Unique Broadband Systems, Inc. (Re), 2014 ONCA 538 (UBS). Although the decision is based on unique underlying facts, it offers several important lessons on corporate governance.

Summary of Facts

In UBS, the Court of Appeal considered a trial decision in which Mesbur J. had found that Gerald McGoey, the former CEO and a director of UBS, had breached his fiduciary duties to the corporation and therefore deprived Mr. McGoey of certain compensation, indemnification for his legal and other professional services expenses, and severance payments.

UBS had issued units under a Share Appreciation Rights (SAR) plan to its directors and management, which was designed to incentivize them based upon the anticipated appreciation in the UBS share price after certain triggering events.  When the share price did not rise as had been anticipated, the directors unanimously resolved to cancel the SAR units and instead establish a SAR cancellation scheme that awarded SAR unit-holders – including Mr. McGoey and three other directors – payments as if the shares were trading at $0.40 instead of the $0.15 range at which they were actually trading.  The board also considered and approved bonuses for certain personnel, including Mr. McGoey.

Both the SAR cancellation payments and bonuses were met with resistance by UBS' shareholders, who voted out Mr. McGoey and the other directors at a special meeting called shortly thereafter.  Prior to this meeting, Mr. McGoey caused UBS to advance to him monies for anticipated legal fees and he resigned as CEO.

The Court of Appeal upheld the trial decision that Mr. McGoey had violated his fiduciary obligations to UBS by approving executive compensation terms that were not in UBS' best interests.  As a result, the Court determined that Mr. McGoey was not entitled to the SAR cancellation payments, the indemnification or other enhanced severance he was seeking.  The Court noted:

Courts will defer to business decisions honestly made, but they will not sit idly by when it is clear that a board is engaged in conduct that has no legitimate business purpose and that is in breach of its fiduciary duties.  In the present case, there was ample evidence upon which the trial judge could base her conclusion that the presumption had been rebutted (para. 72).

Six Key Lessons

  1. Directors are only protected if they exercised business judgment in good faith.  To benefit from deference, directors must meet the "preconditions" of "honesty, prudence, good faith, and a reasonable belief that [their] actions were in the best interests of the company" (para. 71).  In practice, where the facts are such that good faith would appear dubious, the directors may need to be able to point to real evidence of good faith and honesty.  In UBS, the trial judge had found no evidence justifying the selection of the $0.40 price point and "no credible analysis" on the board's part to show how the payments might be fair and reasonable (para. 50).  Both the trial judge and the Court of Appeal found the price "unjustified and unrealistic" (para. 57).  The Court upheld the trial judge's decision noting the absence of "any credible evidence regarding the bona fides" of the SAR cancellation scheme (para. 56).
  2. Documented evidence of business judgment on executive compensation matters is prudent. The Court of Appeal went some distance in noting the absence of evidence one might expect from a board in making compensation decisions.  UBS had neither sought nor received expert advice on an appropriate bonus structure (para. 59), did not consider comparable marketplace data (para. 59), did not document performance factors or criteria (para. 60); and did not document the quantification of the Bonus Pool (para. 61).  In contrast, UBS led evidence at trial from an executive compensation expert, permitting the trial judge to find that the compensation "did not pass any test of reasonableness" (para. 27).
  3. Merely seeking legal advice may not be enough.  In UBS, the Court of Appeal rejected the argument that the directors' decision was grounded in legal advice because some advice had been sought and the lawyer was present for part of the meeting.  Directors had received general advice from counsel on their fiduciary duties in relation to determining compensation, but counsel was not asked to opine on the board's process or the actual benefits being awarded.  In fact, the Court found that the board had not provided counsel with information about the quantum of the proposed payments (para. 69).
  4. Disclosure of a director's interest in a corporate decision does not relieve him or her of the duty to act honestly and in good faith with a view to the best interests of the corporation. Although the UBS directors disclosed their interest in the SAR cancellation payments, the Court was not satisfied that their decision had a valid business purpose and found it was not in the best interests of the corporation.  On those facts, the absence of any evidence on the fairness and rationale of the scheme made it difficult for the Court to view the payments as anything but self-interested.
  5. Management contracts will be interpreted consistently with statutory corporate duties. The Court of Appeal disagreed with the trial judge on the one issue that Mr. McGoey had been successful on at trial – the interpretation of a management agreement that entitled him to enhanced severance.  The Court of Appeal found that the agreement had to be interpreted in light of the OBCA's s. 134(3) which provides that no contractual provision "relieves a director or officer from the duty to act in accordance with this Act and the regulations or relieves him or her from liability for a breach thereof."  The Court found that the trial judge's interpretation of the agreement would improperly permit Mr. McGoey to benefit from the fact that the shareholders had prevented what the Court determined was a "serious breach of fiduciary duty" (paras. 102-103).  The Court also noted, without deciding the issue, that such a severance payment might have constituted oppression (para. 107).
  6. The absence of actual damages does not matter. In UBS, Mr. McGoey had argued that the breach was "incomplete" because his removal at the special meeting meant he had never received the proposed payments (para. 63).  The Court strongly rejected this argument, noting 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 beneficiary's vigilance from receiving a personal benefit" (para. 66).

The authors gratefully acknowledge the assistance of Roya Baryole with this article.

To view original article, please click here.

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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