It won’t change or strengthen any laws around executive compensation but a recent decision from the Ontario Court of Appeal should have boards giving sober second thought to how they grant big bonuses and golden parachutes to top executives.
On July 10, the Court of Appeal
ruled in favour of Unique Broadband Systems and against Jolian Investments Ltd. and Gerald McGoey, the former CEO at UBS and Look Communications. UBS, which went into bankruptcy protection in July 2011, owned a controlling interest in Look Communications. McGoey had employment contracts with a “golden parachute” clause that granted him enhanced termination benefits in certain situations.
In July 2010, a dissident group convened a special meeting of shareholders to remove McGoey and co-directors. After being removed as a director, McGoey commenced a $9.5-million claim against UBS for his compensation awards and a payout pursuant to his management services contract with the company. McGoey contended his contract with the company was terminated without cause as a result of his removal from the board by shareholders.
McGoey’s lawsuit put UBS in a tough financial position due to its limited cash resources. The company 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. Further, UBS established a procedure in the CCAA proceeding to adjudicate disputed claims against it, including McGoey’s.
At trial, UBS was successful in dismissing McGoey’s claim for payment of the compensation awards. The trial judge held 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 upheld the trial judge’s findings that McGoey, who was both CEO and director at UBS and Look, breached his fiduciary duties owed to UBS and its shareholders and held he was not entitled to receive millions in enhanced severance as a result of his wrongful conduct.
The court said 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.”
“Both the trial decision and the Court of Appeal decision reaffirms the prudence of securing outside opinions for market compensation,” says Clifford Cole, a partner at Gowlings Lafleur Henderson LLP who represented UBS in the appeal. “Whether that’s an outside consultant or auditors, the securing of outside, third-party objective opinions to assist in deciding on compensation is something this case addresses and is one of a very few cases that makes clear what directors should be doing.”
Cole says the decision gives boards a moment of pause — “particularly ones that generally don’t secure that kind of outside advice. The conduct was exactly as the trial judge described — it lacked honesty, lacked good faith, and was not in the best interest of the corporation.”
Lawyer Joe Groia represented McGoey at trial and the appeal. He argued McGoey had not breached his fiduciary obligations. He outlined the efforts that were made to try and make a decision “justifiable in reasonable business judgment.”
“McGoey was never paid a dime of the bonuses so in terms of the company having suffered a financial loss it didn’t because the payments were never made. He had a contract saying if fired, he was entitled to the payments. The fact the court said he not only didn’t get the enhanced payments but also the basic payments as well was a very strong statement,” says Groia. “Obviously McGoey is disappointed. He respects the court’s decision but from his perspective I think he feels he’s been doubly punished for the decisions he made that the court disagreed with.”
Law professor Richard Leblanc who teaches and advises on governance and ethics says McGoey and the directors “exercised no business judgment” and the actions “smacked of massive self-interest.”
Leblanc said the board should have had independent directors and hired independent advice for the compensation committee.
While UBS did consult with outside legal counsel regarding board approval of executive bonuses, it was told that while s. 3.15 of National Policy 58-201, which deals with corporate governance guidelines, says a board should appoint a compensation committee entirely of independent directors, it is “a guideline only” and not a requirement or pursuant to securities law or TSX rules.
“It’s astounding that directors could allow the CEO to sit on the compensation committee and award himself this kind of compensation agreement. It’s always highly advisable to seek independent advice in these situations when you’re awarding yourself a compensation package,” says Leblanc.
Cole says the decision also clarifies the business judgment rule.
“Many members of less sophisticated boards and companies think the business judgment rule is pretty much an absolute defence so long as they act reasonably and prudently. That’s not correct. They have to act honestly and prudently but have an informed basis on which to make a decision,” he says.
Cole says it’s the only case that speaks to the ability to contract out of or around fiduciary duties. The Court of Appeal interpreted a portion of s. 134 of the Ontario Business Corporations Act that says one cannot contract out of these duties.
“In this case the director had an employment contract that could arguably be read to allow him to contract out of his fiduciary duties but the Court of Appeal disagreed,” says Cole. “That fiduciary responsibility is absolutely critical — you cannot contract out of it. This is where I think the case nails things down and is precedent setting in that respect.”
Groia questions whether all of the legal wrangling to oppose McGoey was ultimately in the best interests of the shareholders.
“I’m not sure what financial position [UBS] is going to be in when all is said and done and when I look at the very serious amounts of money paid to professionals in these cases, even with this decision, somebody needs to ask the question are the UBS shareholders better off than they would be or should have been?”
He says if McGoey had obtained compensation advice it may have made a difference but believes the same situation would have evolved.
“The new board was determined not to pay him so the trial would have been different in that there would have been a compensation expert on the side of the company and Mr. McGoey would have had an expert on the side of the old board,” he says. “I don’t see UBS having said we will let McGoey keep his bonus because he got a report from [compensation consultants] Mercer.”
At the appeal, Groia argued there is case law saying if you breach a fiduciary obligation it doesn’t necessarily mean you are not entitled to be paid a bonus or not entitled to be paid for termination allowances.
In
Mady Development Corp. v. Rossetto, Leonard Rossetto, the vice president of the company, was found to have diverted resources from his employer towards renovations of his home. He sued for the payment of his bonus and the court found he was entitled to the bonus because he earned it.
“The fact he breached his fiduciary obligation after he earned the bonus doesn’t mean the company gets to wipe out all the things done in the past,” says Groia.
“I argued that’s exactly what UBS wanted to do with Mr. McGoey because if you take away the enhanced bonus and the other payments here’s a guy who worked for eight years who had an employment contract,” he says.
Groia says the decision whether or not to seek leave to appeal is still available to McGoey.
