On July 10, 2014, the Ontario Court of Appeal released an important decision regarding corporate governance and shareholders rights. In the case between Unique Broadband Systems Inc. and its former CEO and director, Gerald McGoey, the Court of Appeal clarified the fiduciary obligations on the part of officers and directors of both private and public companies as well as the limitation on the business judgment rule that limits a Court from “second guessing” decisions of management. The Court of Appeal decision is also the first decision to review the prohibition set out in the Ontario Business Corporations Act that prohibits a corporation and its officers and directors from contracting out of these duties.
Prior to the commencement of litigation, the former directors of UBS and a company in which UBS held a controlling interest for which McGoey also served as a director and CEO, awarded themselves “extraordinary” compensation in excess of $20 million (the cost to UBS represented virtually 100 per cent of the market capitalization of UBS). The compensations awarded by the UBS Board were made in the absence of a bonus policy, independent compensation expert advice, market data, or any other objective criteria.
When these compensation awards were disclosed, a group of concerned shareholders requisitioned a special meeting of shareholders. With the assistance of legal counsel, Kelley McKinnon, Tina Woodside, Kathleen Ritchie and Benjamin Na, all of Gowling Lafleur Henderson LLP, these shareholders succeeded in a highly contested proxy fight to remove and replace the directors from the Board, including McGoey.
After being removed as a director, McGoey commenced a claim against UBS of $9.5 million for his extraordinary compensation awards and for a “golden parachute” payment pursuant to his management services contract with the company. McGoey contended that his contract with the company was terminated without cause as a result of his removal from the Board by shareholders.
The lawsuit by McGoey placed UBS in an untenable financial position due to its limited cash resources. UBS was forced to commence a proceeding under the Companies’ Creditors Arrangement Act. In the CCAA proceeding, there were many attempts to wrestle control of the company from the new directors that UBS successfully defended with its insolvency and restructuring counsel, Patrick Shea, and commercial lawyer, Bryce Kraeker (all of Gowlings). Further, UBS established a procedure in the CCAA proceeding to adjudicate the disputed claims against UBS, including McGoey’s.
At trial, UBS was successful in dismissing McGoey’s claim for payment of the extraordinary compensation awards. The trial judge held that McGoey breached his fiduciary duty, acted in his own self-interest, and failed to act honestly and in good faith with the best interests of the company and its shareholders. However, the trial judge also held that McGoey was entitled to a golden parachute payment under his contract notwithstanding his breach of fiduciary duties. Both UBS and McGoey appealed the trial decision.
The Court of Appeal granted the UBS appeal and disallowed any contractual entitlement to a golden parachute payment. The Court of Appeal also dismissed McGoey’s appeal and held that he was not entitled to his compensation awards.
In so doing, the Court of Appeal reaffirmed the nature and importance of fiduciary duties and standard of care required of officers and directors of both public and private corporations. It stated that officers and directors have a “specific obligation to scrupulously avoid conflicts of interests with the corporation and not to abuse [their] position for personal gain”.
The Court’s decision also clarified the business judgment rule which protects officers and directors from review by a Court of a business decision made by them. The Court made it clear that this rule only applies in the event that an officer or director has satisfied 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 further stated that the rule is “really just a rebuttable presumption” and 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.”
Equally important is the Court of Appeal’s ruling that a corporation and its officers and directors cannot contract out of the fiduciary and related duties set out in section 134(1) of the Ontario Business Corporations Act. A contractual provision that expressly or impliedly excludes a breach of fiduciary duty as a ground for termination for cause would effectively “eviscerate” the prohibition set out in section 134(3) of the Act. Although unnecessary to its decision, the Court of Appeal commented that such a contractual provision might constitute oppression pursuant to section 248 of the Act. The Court of Appeal stated that the oppression remedy is a “flexible” remedy that affords “the court broad powers to rectify corporate malfeasance” and is “an important remedy for shareholders and corporate stakeholders”. In the circumstances of this case, it “may well have provided a remedy to protect the interests of shareholders”.