The following is a story of executive compensation gone awry.
In 2003, Unique Broadband Systems, Inc. (UBS), a public company listed on the TSX Venture Exchange, acquired a 51.8% controlling interest in Look Communications (Look), a telecommunications company that owned a band of telecommunications spectrum. UBS was a holding company, and Gerald McGoey was its CEO and a UBS director.
In May 2004, Gerald McGoey became vice-chairman and CEO of Look while retaining his role at UBS. Look paid UBS an annual fee of $2.4 million for Mr. McGoey’s services.
The Terms of Mr. McGoey’s Employment
Mr. McGoey had negotiated with UBS an employment contract providing him an annual compensation of US$360,000, an annual bonus at UBS’s discretion, stock options and an indemnity for legal expenses except where there was cause. According to the employment agreement, if he was not re-elected to the board of directors or nominated as CEO, he was to be paid 300% of his base salary, a bonus based on bonuses paid in prior years and 50% of stock options that were not yet granted but would have been granted had he completed his term (Severance).
In May 2006, the employment agreement was replaced with a management services agreement between UBS and Mr. McGoey’s personal company, Jolian Investments Limited (Jolian). Although the Jolian agreement was very similar to the prior employment contract, the Jolian agreement provided that, upon a “Jolian Default,” UBS could terminate the agreement and would be required to pay only the base salary due and a pro rata share of any bonus actually awarded at the time of termination. Jolian Default was defined as:
- An act of fraud, theft or misappropriation or other act which constitutes “cause” at common law committed by the CEO designee; and
- The material failure by the CEO designee to perform the CEO services after having received written notice of such material failure and been given reasonable time to correct same; in each case, which is materially injurious to UBS or has not been waived by UBS.
The Jolian agreement also reimbursed Mr. McGoey for legal expenses except where there was “Cause,” which was defined as “fraud, embezzlement, or misappropriation or other act which constitutes ‘cause’ at common law, which is materially injurious to” UBS.
The SAR Plan
In November 2006, UBS established a share appreciation rights plan (SAR Plan). The SAR unitholders were to be paid the value of their SAR units at, among other dates, the date at which UBS sold all or substantially all of its assets. The SAR Plan described the value of the SAR units as the average closing board lot sale price of common UBS shares on the TSX Venture Exchange on the last day preceding the day on which the common shares were traded. Mr. McGoey was a SAR unitholder.
The Look Sale
In order to sell Look’s telecommunications spectrum at maximum value, Mr. McGoey decided to accomplish the sale of the spectrum through a statutory plan of arrangement in order to create a bidding process among the likes of Rogers, Bell, Shaw and Telus. However, on February 16, 2009, only one bid was received, from a Bell/Rogers partnership, for a disappointing $80 million (Sale).
On May 11, 2009, UBS issued a press release stating that the Sale had yielded a fully diluted price per share of 44 cents, which was calculated simply by dividing the $80 million by the number of outstanding Look shares and did not represent an actual valuation of UBS and Look, nor did it account for any expense of or compensation payment made as a result of the Sale.
On May 14, 2009, the court approved the Sale. The terms of the Sale provided that the first $30 million was to be paid on court approval, May 14, 2009; the next $20 million was to be paid no later than December 31, 2009; and the last $30 million was to be paid no later than 36 months after the closing or when regulatory approval was obtained, if earlier. The Sale actually closed earlier than anticipated, on September 11, 2009.
The Sale failed to increase the share price of both UBS and Look beyond the original 15 cents per UBS share and 20 cents for Look shares.
Beginning in May 2009, Mr. McGoey attempted to sell to Rogers either Look’s remaining assets, valued at $300 million, or UBS’s Look shares, for $76 million (or 40 cents a share). However, the negotiations were difficult and Rogers withdrew from negotiations on July 20, 2009.
The Sale was considered by both Look and UBS as a sale of all or substantially all of their assets (since the spectrum made up the bulk of Look’s assets and Look was UBS’s only real asset). Shortly after the court approved the Sale, UBS and Look management began to deal with SARs and options as part of a restructuring which Mr. McGoey believed would be required because of the Sale. This is when things began to go wrong.
First, both the UBS and Look compensation committees were made up exclusively of Mr. McGoey and other members of either board, all of whom were SAR unitholders.
Second, instead of making SAR payments based on the terms of the SAR Plan, the UBS compensation committee decided to cancel the SAR Plan and replace it with a fixed compensation payment whereby each SAR unitholder would be paid 40 cents per SAR unit. They would also be granted bonuses. These decisions were made without any information about comparable compensation in the market or external advice, and UBS had no written compensation policy.
On June 10, 2009, UBS’s external counsel emailed to Mr. McGoey that although National Policy 58-201-Corporate Governance Guidelines recommended that compensation committees be composed entirely of independent directors, this was not a requirement. On June 17, 2009, the date on which the UBS compensation committee discussed these matters, UBS’s external counsel wrote a letter to the UBS board indicating that, in making payments to officers and employees, the board was required to continue to meet its fiduciary obligations; and a director’s fiduciary duties involve the duty to act in the best interests of the corporation, honestly and in good faith with a view to the best interests of the corporation, and to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
During the June 17, 2009, UBS compensation committee meeting, the directors disclosed their conflict of interest and unanimously resolved to cancel all SAR units as of May 31, 2009, award SAR cancellation payments conditional upon Look receiving the full $80 million consideration, and approve a SAR cancellation payout pool of $2,310,000. At a subsequent UBS board meeting held on July 8 and 9, 2009, the directors also resolved to establish a bonus pool of $3.4 million.
At a board meeting held on August 28, 2009, Mr. McGoey, through Jolian, was allocated just over $600,000 on account of his cancelled SAR units (SAR Cancellation Payout) and $1.2 million (Bonus) of the $3.4 million bonus pool.
Fallout and Legal Proceedings
After questioning the use of 40 cents as a fair market value and the lack of external assessment to support its reasonableness, KPMG, UBS’s auditors, issued a clean audit report. Financial statements containing particulars of the SAR cancellation and bonuses were disclosed in the Management Information Circular sent to shareholders prior to the February 2010 annual general meeting. A group of shareholders, alarmed by the amounts of compensation, launched a proxy battle for control of the board. At a special shareholder meeting held in May 2010, the board was replaced. Mr. McGoey resigned as CEO of UBS, and the new board did not reappoint him.
Mr. McGoey took the position that he had been terminated without cause pursuant to the terms of the Jolian agreement and demanded payment of the Severance. UBS refused. Mr. McGoey sued UBS. When UBS sought protection under the Companies’ Creditors Arrangement Act (CCAA), Mr. McGoey asserted his claim as part of the claims determination process in the CCAA proceedings in the amount of $7,632,300 for the Severance, $1,256,677 for the Bonus, $628,338 for the SAR Cancellation Payout and $595,333 in legal expenses, for a total of $10,112,648. The CCAA Monitor disallowed Mr. McGoey’s proof of claim in its entirety.
The SAR Cancellation Payout and Bonus
The Court of Appeal of Ontario agreed with the Superior Court of Justice that the business judgment rule, pursuant to which courts defer to board decisions, would assist Mr. McGoey only if he had acted in accordance with his fiduciary duties toward UBS, which he had not. Neither the correspondence from UBS’s external counsel nor the fact that KPMG had issued the audit report supported Mr. McGoey’s actions.
The 40 cent unit value used to determine the SAR Cancellation Payout was not determined by an objective means, did not reflect the actual market value of the shares and was unjustified and unrealistic. According to the Court of Appeal, what the SAR Cancellation Payout
[excerpt begins]really achieved was the removal of the uncertainty that was part of the SAR Plan. Under this new scheme, the recipients’ awards were not dependant on an increase in the share price, the awards would be granted regardless of the trading price of the shares. This removal of the uncertainty was to the benefit of the recipients and was not to the benefit of the corporation. (para. 57) [excerpt ends]
Similarly, the Bonus was not based on any objective criteria. Given this breach of fiduciary duty, these amounts were not owed to Mr. McGoey.
The Court of Appeal of Ontario disagreed with the Superior Court that the Severance should be paid to Mr. McGoey.
The Superior Court read the definition of Jolian Default as requiring that the actions in both paragraphs (a) and (b) of that definition be met. Therefore there had to be both an act of fraud, theft or misappropriation or other act constituting cause at common law and material failure by Mr. McGoey to perform services after having received written notice of such material failure. It also determined that Mr. McGoey had not committed the acts listed in paragraph (a), and that if a breach of fiduciary duty were to be included as a Jolian Default, the parties to the Jolian agreement would have said so. Given the fact that there had therefore been no Jolian Default, and despite the trial judge’s finding that Mr. McGoey had breached his fiduciary duty, the court held that he was owed the Severance since he had not been re-elected to the board of directors or nominated as CEO.
The Court of Appeal took a different tack. It determined that it was not necessary that both paragraphs (a) and (b) of that definition be met despite the conjunctive “and,” and that a breach of fiduciary duty was included in paragraph (a). It reviewed the principles that a commercial contract should be interpreted in a manner consistent with commercial principles and that a contractual interpretation should not result in rendering the agreement unlawful, and held that the trial judge had ignored subsection 134(1) of the Ontario Business Corporations Act(OBCA), which requires that a director or officer act honestly and in good faith with a view to the best interests of the corporation, and subsection 134(3) of the OBCA, which prohibits a contract from relieving a director or officer from the duty to act in accordance with the OBCA. To find that Mr. McGoey’s breach of fiduciary duty was not a Jolian Default would amount to eviscerating the prohibition in the OBCA.
In a proceeding prior to the CCAA proceeding, Mr. McGoey had successfully moved for summary judgment on the issue of the payment of legal expenses. However, the motion judge had held that such payments by UBS to Mr. McGoey were subject to any findings of misfeasance, and that indemnification under the USB by-laws was available only if the director or officer had acted honestly and in good faith with a view to the best interests of UBS. Despite the almost identical language in paragraph (a) of the definition of Jolian Default and the definition of Cause in the Jolian agreement, and the trial judge’s findings with respect to the Severance, the trial judge held that Mr. McGoey was not entitled to be reimbursed his legal expenses. The Court of Appeal agreed.
What Does This Mean?
As a matter of good corporate governance, it is imperative that a corporation ensure the independence of those who are tasked with deciding how directors and officers are to be remunerated. In addition, expert advice should be sought and such advice recorded before any change is made to a compensation program which is likely to benefit directors and officers.