Court of Appeal reiterates that business judgment rule is a
rebuttable presumption; lack of expert advice to support, or
reasonable, objective justification of, board decisions fatal to
reliance
This appeal was of trial findings that (a)
Unique Broadband Systems, Inc. ("UBS") was liable to its
former CEO Gerald McGoey for enhanced severance, and (b) that Mr.
McGoey was not entitled to certain compensation awards and for
indemnification for legal and other expenses. UBS held an interest
in Look Communications Inc. ("Look"), the primary asset
of which was a band of telecommunications spectrum that, after an
auction process, sold for a less than anticipated $80 million. It
was expected that the sale would increase the share price of UBS.
When this did not happen (the price remained in the range of
$0.15), the board cancelled its stock appreciated rights
("SAR") plan and established a SAR cancellation payment
pool using a price of $0.40 a share. It then also created a bonus
pool of $3.4 million. Similar pools were established at Look. All
in, the pools contained almost $15 million, which the Court noted
was 97.6% the market capitalization of UBS. Mr. McGoey received
$600,000 as his SAR cancellation award, $1.2 million from the bonus
pool (to be paid on receiving the $80 million) and $5,565,696 in
"Restructuring Awards" directly by Look. McGoey later
received $200,000 to cover legal fees after shareholders began to
object to these other payments. McGoey was removed from office by
the shareholders, prompting him to resign as CEO. He argued that he
had been terminated because he was not re-elected to the board,
entitling him to enhanced severance of $9.5 million under his
services agreement with UBS.
Directors need to act in an informed manner, in good
faith, and in the best interests of the corporation to take
advantage of the "business judgment rule"; documenting
the basis of a decision and independent and expert advice will
provide evidence of this. At trial, it was determined that
Mr. McGoey breached his fiduciary duty to UBS and was not entitled
to either his SAR cancellation payment nor his bonus payment. That
the business judgment rule would only be of assistance to Mr.
McGoey if he acted honestly and in good faith, with a view towards
the best interests of the corporation, was the basis on which the
actions of Mr. McGoey were examined. The trial judge focused on the
use of a share price of $0.40, which was set at a time that the
board knew that the market did not view the sale of the spectrum
assets as favourably as the board did, and which was set by a
compensation committee with no disinterested members as all held
SARs (although each disclosed their interest in the SAR
cancellation awards). She found "the decision... [was] driven
by the board's own self interest, and not the interests of the
corporation. There was nothing in it for UBS shareholders. As for
Mr. McGoey's bonus, there was no business rationale for
it". In short, the $0.40 share price was not objectively set
and did not reflect the actual market price. The board decided to
implement the SAR cancellation awards without the benefit of any
independent or third party advice that might support their
decision. Similarly, the bonus pool was created without any expert
advice or any comparable or other executive compensation data. No
documentation was provided to show how the size of the pool was
determined. The Court of Appeal upheld the trial finding that the
business judgment rule was of no assistance to Mr. McGoey because
he did not satisfy the rule's preconditions of honesty,
prudence, good faith, and a reasonable belief that his actions were
in the best interests of the company. The Court of Appeal reminds
us that the rule is a rebuttable presumption that directors or
officers act on an informed basis, in good faith, and in the best
interests of the corporation - a board that is engaged in conduct
that has no legitimate business purpose and that is in breach of
its fiduciary duties will not be provided deference.
Fiduciary duties and corporate law will inform the
interpretation of contracts with executives. At trial, it
was found that Mr. McGoey was entitled to enhanced severance as a
breach of fiduciary duty was not found to be cause or a default, as
such terms were defined under Mr. McGoey's services agreement.
Interestingly, the interpretation at trial as to what constituted a
default under Mr. McGoey's services agreement turned on the use
of the word "and", which appeared to require the
occurrence of two events as preconditions to a default under the
agreement. The trial judge interpreted it in the conjunctive sense.
The Court of Appeal found that the interpretation of the agreement
at trial would result in a commercially absurd result, whereas
interpreting the "and" as "or" did not, which
is a principle of contractual interpretation. This was supported by
s. 134(3) of the Business Corporations Act (Ontario) which states
that no contract "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". Interpreting
the "and" in the conjunctive sense would relieve Mr.
McGoey of his obligation to act in a manner that is consistent with
his fiduciary duties and receive the enhanced severance under the
services agreement.
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