Canada: Not Unique: Ontario Court Of Appeal Reaffirms That Reliance On Business Judgment Rule Requires Compliance By Directors With Duty Of Loyalty

Last Updated: August 2 2014
Article by Paul Collins

The Ontario Court of Appeal has recently reconfirmed that the court's deference to business decisions made by boards of directors, known as the "business judgment rule", will not apply where the directors have breached their statutory duty of loyalty. The Court also confirmed that contractual provisions that have the effect of contracting out of the statutory duties imposed on directors and officers by the Ontario Business Corporations Act ("OBCA")1 will not be upheld. The Court of Appeal rejected the claim by a former CEO of Unique Broadband Systems, Inc. ("UBS"),2 for payment of certain compensation awards and overturned the lower court's ruling that the CEO was entitled to receive a 'golden parachute' severance payment.

Gerald McGoey was a director and the CEO of UBS, a TSX Venture Exchange listed company, and was also a director and the CEO of its 51.8% owned subsidiary, Look Communications Inc. ("Look"). UBS had in place a share appreciation rights ("SAR") plan, pursuant to which participants would be paid an amount per SAR unit equal to the difference between the unit strike price and the market price of the UBS shares upon the occurrence of a triggering event. In December 2008, Look initiated a court-supervised process to sell a significant portion of its assets. The UBS directors determined that completion of the sale by Look would be deemed to be a triggering event for purposes of the SARs. The sale of the Look assets was completed in May 2009, but contrary to expectations, the market price of the UBS shares did not appreciate following completion of the sale, continuing to trade in the $0.15 range. In June 2009, the UBS board met and decided to cancel the outstanding SARs in exchange for aggregate payments to SAR holders of $2.3 million, which amount was based on an assumed $0.40 market price for the UBS shares. All of the directors held SARs and declared their interest. Cancellation of the SARs would result in McGoey receiving $600,000, as compared to a payment of $75,000 under the original terms of the SAR plan. The UBS board also established an aggregate bonus pool of $3.4 million, of which McGoey would receive $1.2 million. Prior bonus payments to McGoey had been in the $400,000 range. Similar actions were also taken by Look's board of directors, with the result that the total amount to be funded by UBS under both companies' plans would be approximately $14.6 million, or in excess of 97% of the market capitalization of UBS.

Dissident UBS shareholders convened a meeting in July 2010 and were successful in replacing the incumbent directors. McGoey took the position that as he had not been re-elected as a UBS director, he had been terminated as its CEO without cause and brought an action seeking payment of the SAR cancellation and bonus amounts, as well as his severance entitlements under his contract with UBS. The severance entitlement was equal to 300 percent of McGoey's annual compensation. The trial judge rejected McGoey's claims for the SAR cancellation and bonus amounts but upheld his claim to receive the golden parachute payment.

The OBCA requires directors and officers to act honestly and in good faith with a view to the best interests of the corporation.3 This duty of loyalty requires that directors act in an impartial, disinterested manner with decisions being taken based on reasonable beliefs and for rational business purposes, and not for purposes of self interest. The Court noted that officers and directors must "scrupulously avoid"4 conflicts of interest with their corporation and not abuse their position for personal gain. The OBCA also requires directors and officers to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.5 This does not mean that every decision of the directors must be found in hindsight to be perfect. Canadian courts have adopted and continue to strongly endorse the business judgment rule, whereby courts will defer to the business judgment that the board has exercised in a particular manner, provided that the directors have made an informed and reasonable decision. As previously stated by the Supreme Court of Canada:

Courts are ill suited and should be reluctant to second-guess the application of business expertise to the considerations that are involved in corporate decision making, but they are capable, on the facts of any case, of determining whether an appropriate degree of prudence and diligence was brought to bear in reaching what is claimed to be a reasonable business decision at the time it was made.6

The Court found there was no credible evidence of the bona fides of the SAR cancellation payments, including the $0.40 per share valuation. The UBS board implemented the SAR cancellation without the benefit of independent oversight (as all of the directors held SARs) or third party advice. The $0.40 valuation had not been determined by any objective means and did not reflect the actual market price of the UBS shares. While fixing the SAR value was clearly beneficial to the holders, there was no reciprocal benefit to UBS. Similarly, the UBS board had not received any expert advice on an appropriate bonus structure, nor did it have any documentation reflecting comparable or other market data on executive compensation. While disclosure by a director or officer of his personal interest in a transaction was required as an initial step, it was not sufficient to relieve a director of his obligation to act honestly and in the best interests of the corporation.

The Court characterized the business judgment rule as a "rebuttable presumption"7 that in reaching the decision made, the directors had acted on an informed basis, in good faith and in the best interests of the corporation. However, this presumption will only apply where the preconditions of honesty, prudence, good faith and a reasonable belief that one's actions were in the best interests of the corporation, had been met. The Court concluded that the presumption had been rebutted, noting that: "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".8

The Court also refused to allow the golden parachute payment to McGoey. Section 134(3) of the OBCA provides that: "no provision in a contract, the articles, the by-laws or a resolution relieves a director or officer from the duty to act in accordance with this Act...or relieves him or her from liability for a breach thereof."9 The Court refused to interpret a contractual provision so as to exclude a breach of fiduciary duty as a ground for termination, since this would "eviscerate"10 the prohibition in s.134(3).

The Court's decision in UBS is consistent with previous Canadian decisions, including the Ontario Court of Appeal's decision in Repap,11 which also involved executive compensation. Decisions by directors will continue to be protected to the extent that their actions actually evidence the exercise of business judgment. In Repap, an extremely lucrative employment agreement was awarded to the Chairman after a seven minute meeting of the compensation committee, which although having received an outside consultant's opinion, had provided the consultant with only cursory information and had not questioned the consultant's opinion or the basis of its recommendation. The Committee and the consultant had also not been advised by the Chairman that other directors had resigned rather than approve the employment agreement. The Court of Appeal upheld the lower court's decision to set aside the employment agreement, having concluded that the Chairman had breached his fiduciary duty to the corporation and that the other directors had violated their duty of care by not making a decision on an informed and reasoned basis. The directors had not informed themselves sufficiently or given proper oversight to their outside advisor, and therefore could not be said to have exercised their business judgment.

What does this mean for directors? Avoid conflicts of interest and the appearance of conflicts of interest. Obtain independent advice from experts, but do not rely on their advice unquestioningly. Any decision process must be characterized by the elements of independence, investigation, due deliberation and the exercise of business judgment.

It is also important to note that while unnecessary to its decision, the Court in UBS foreshadowed its willingness to consider the use of the oppression remedy in cases such as this by noting that the oppression remedy may have provided a remedy in the circumstances and that it may be used by a court to "rectify corporate malfeasance".12

Footnotes

1 RSO 1990, c. B16 [OBCA].

Unique Broadband Systems, Inc. (Re), 2014 ONCA 538 [UBS].

OBCA, supra note 1, s 134(1). See also Canada Business Corporations Act, RSC 1985, c C-44, s 122 [CBCA].

UBS, supra note 2 at para 46.

OBCA, supra note 1, s 134(1).

Peoples Department Stores Inc. (Trustee of) v Wise, 2004 SCC 68 at para 67.

UBS, supra note 2 at para 72.

Ibid at para 72.

OBCA, supra note 1. See also CBCA, supra note 3, s 122(3).

10  UBS, supra note 2 at para 97.

11  UPM-Kymmene Corp. v UPM-Kymmene Miramichi Inc., 2002 CanLII 49507 (ON SC), (2002), 214 DLR (4th) 496 (Ont SC), aff'd 2004 CanLII 9479 (ON CA), (2004), 183 OAC 310 (CA).

12  UBS, supra note 2 at para 107.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2014

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions