UNIT 7 (WEEKS 10 & 11): THE (FIDUCIARY) OBLIGATIONS OF CORPORATE MANAGEMENT

UNIT 7 (WEEKS 10 & 11): THE (FIDUCIARY) OBLIGATIONS OF CORPORATE MANAGEMENT

 

Figure 7: Corporate Management

ALT: A large duck leads a group of smaller ducks through a pond.

Source of image – Morguefile http://www.morguefile.com/archive/#/?q=leadership&sort=pop&photo_lib=morgueFile

Image URI: http://mrg.bz/KRHGCA

 

UNIT OVERVIEW:

In this unit the legal and fiduciary obligations of management and directors; the scope of those obligations and to whom they are owed; and the constraints on those powers and limitations shall be examined.

 

UNIT OUTCOME:

One of the realities inherent to separate corporate personhood is the strange asymmetry that the corporate person can only act as a result of and through human action and interaction. Corporate takeovers and changes of control highlight how vested interests and other frailties of the human condition complicate corporate life. You will be introduced to the kind of legal mechanisms and maneuvers used to resist takeovers (including “poison pills”) as well as the limits of the legitimate use of such tactics. Conflicts of interest situations as well as personal opportunities that arise through the corporation are other situations where similar factors of human frailty come into play. By the end of this unit you will develop an understanding of what it means for directors and officers to act “in the best interests of the corporation” when changes are happening.

 

UNIT READINGS:

Please review the following materials:

Casebook pages 509-822

BCBCA sections 136-137, 142, 157; CBCA sections 122-123, 147-153; Securities act (B.C.) sections 57.2

Parke v. Daily News Ltd. [1962] 2 All E.R. 929

Re. W and M Roith Ltd. [1967] 1 All E.R. 427

CW Shareholdings Inc. v. WIC Western International Communications Ltd. (1998), 39 O.R. (3d) 755 (Ont. S.C.) http://www.canlii.org/en/on/onsc/doc/1998/1998canlii14838/1998canlii14838.html

 

TOPIC 1: LEGAL OBLIGATIONS OF MANAGEMENT: THE STANDARD OF CARE, DILIGENCE AND SKILL

Please review pages 509-822 of the Casebook

 

A. Statutory Provisions

BCBCA section 142(1): “A director or officer of a company, when exercising the powers and performing the functions of a director or officer of the company, as the case may be, must . . . (b) exercise the care, diligence and skill that a reasonably prudent individual would exercise in comparable circumstances.”

CBCA section 122(1): “Every director and officer of a corporation in exercising their powers and discharging their duties shall . . . (b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.”

 

B. The Common Law Background

Please refer to the judgment in Peoples Department Stores Inc. v. Wise, a case we have already visited in this course. There you will find the following (also at pages 624-625 of the Casebook):

“That directors must satisfy a duty of care is a long-standing principle of the common law, although the duty of care has been reinforced by statute to become more demanding.  Among the earliest English cases establishing the duty of care were Dovey v. Cory, [1901] A.C. 477 (H.L.); In re Brazilian Rubber Plantations and Estates, Ltd., [1911] 1 Ch. 425; and In re City Equitable Fire Insurance Co., [1925] 1 Ch. 407 (C.A.).  In substance, these cases held that the standard of care was a reasonably relaxed, subjective standard.  The common law required directors to avoid being grossly negligent with respect to the affairs of the corporation and judged them according to their own personal skills, knowledge, abilities and capacities.  See McGuinness, supra, at p. 776: “Given the history of the case law in this area, and the prevailing standards of competence displayed in commerce generally, it is quite clear that directors were not expected at common law to have any particular business skill or judgment.” (Emphasis added)

 

Also quoted in Peoples Department Stores Inc. v. Wise (at page 625 of the Casebook) was the 1971 Dickerson Report “Proposals for a New Business Corporations Law for Canada”, authored by Robert W.V. Dickerson, John L. Howard and Leon Getz, and which preceded the enactment of the CBCA by four years.

The Dickerson Report:

• Described the common law standard as being the degree of care, skill and diligence that could reasonably be expected from someone having the directors knowledge and experience;
• Recommended at II, ap. 74 the creation of an objective standard requiring directors and officers to meet the standard of a “reasonably prudent person”

This was obviously an attempt to raise the standard of directors. As can readily be seen from CBCA section 122(1) the objective standard was rejected and “reasonable prudence” was put in the context of “comparable circumstances”. This subjective test prevailed and remains with us.

However the jurisprudence does not actually seem to follow the statutory words, and insists on an objective standard. Again please refer to Peoples Department Stores Inc. v. Wise (at pages 625-626 of the Casebook) where the following is said:

“…the words “in comparable circumstances”,  which modifies the statutory standard by requiring the context in which a given decision was made to be taken into account. This is not the introduction of a subjective element relating to the competence of the director, but rather the introduction of a contextual element into the statutory standard of care.  It is clear that s. 122(1)(b) requires more of directors and officers than the traditional common law duty of care outlined in, for example, Re City Equitable Fire Insurance, supra.

The standard of care embodied in s. 122(1)(b) of the CBCA is  . . . an objective standard.  The factual aspects of the circumstances surrounding the actions of the director or officer are important  . . . as opposed to the subjective motivation of the director or officer.” (Emphasis added)

Now please read Soper v. Canada [1998] 1 F.C. 124 (C.A.) at pages 616-618 of the Casebook and note how the court wrestles with the question of standard to be applied to directors.

Under the Income Tax Act the directors of a corporation are not liable for the failure to make employee remittances if the directors show they exercised the degree of care, diligence and skill of a reasonably prudent person in the circumstances.

Robertson J.A. made the following observations on the law:  

“The second proposition that I wish to discuss is the following: a director need not exhibit in the performance of his or her duties a greater degree of skill and care than may reasonably be expected from a person of his or her knowledge and experience…

Third, a director is not obliged to give continuous attention to the affairs of the company, nor is he or she even bound to attend all meetings of the board. However when, in the circumstances, it is reasonably possible to attend such meetings, a director ought to do so. Subsequent English cases, though, went to more of an extreme, permitting a director to avoid liability despite having missed all board meetings for a period of several years…

Fourth, in the absence of grounds for suspicion, it is not improper for a director to rely on company officials to perform honestly duties that have been properly delegated to them. Further to this point, it is the exigencies of business and the company’s articles of association that, together, will determine whether it is appropriate to delegate a duty. The larger the business, for instance, the greater will be the need to delegate…

Hence, in the event that the reasonably prudent person is unskilled (which possibility is discussed above), the statute requires only the exercise of a degree of care which is commensurate with that person’s level of skill. It is in this manner that skill and care are clearly interconnected. That being said, it is worth emphasizing that it is insufficient for a director to assert simply that he or she did his or her best if, having regard to that individual’s level of skill and business experience, he or she failed to act reasonably prudently.” (Emphasis added)

[Please note that the final two paragraphs quoted above are not contained in the Casebook version.]

 

Some further points with respect to Peoples Department Stores Inc. v. Wise:

1. Note the very important distinction drawn below in BCE v. 1976 Debentureholders (discussed earlier in this course), concerning the distinction in the direction of the duty of care and the fiduciary duties:

“A second remedy lies against the directors in a civil action for breach of duty of care. As noted, s. 122(1) (b) of the CBCA  requires directors and officers of a corporation to “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances”.  This duty, unlike the s. 122(1) (a) fiduciary duty, is not owed solely to the corporation, and thus may be the basis for liability to other stakeholders in accordance with principles governing the law of tort and extra-contractual liability: Peoples Department Stores.  Section 122(1) (b) does not provide an independent foundation for claims.   However, applying the principles of The Queen in right of Canada v. Saskatchewan Wheat Pool, [1983] 1 S.C.R. 205, courts may take this statutory provision into account as to the standard of behavior that should reasonably be expected.” (Emphasis added)

2. The business judgment rule is well described in at pages 633-641 of the Casebook in terms of the court not second-guessing “business judgments, as long as they are made in an informed way (and in accordance with fiduciary obligations. It is really just a statement of the principle of curial deference to managerial decisions, which only makes sense since the court has no authority to make such decisions.”
3. The point is made in Peoples Department Stores Inc. v. Wise that directors may rely on others in certain ways, as statutorily permitted. This is not entirely a simple and straightforward rule as the following excerpt illustrates:

“When faced with the serious inventory management problem, the Wise brothers sought the advice of the vice-president of finance, David Clément.  The Wise brothers claimed as an additional argument that in adopting the solution proposed by Clément, they were relying in good faith on the judgment of a person whose profession lent credibility to his statement, in accordance with the defence provided for in s. 123(4) (b) (now s.123(5)) of the CBCA .  The Court of Appeal accepted the argument.  We disagree. 

The reality that directors cannot be experts in all aspects of the corporations they manage or supervise shows the relevancy of a provision such as s. 123(4) (b).  At the relevant time, the text of s.123(4) read:

“123. (4) A director is not liable under section 118, 119 or 122 if he relies in good faith on

(a) financial statements of the corporation represented to him by an officer of the corporation or in a written report of the auditor of the corporation fairly to reflect the financial condition of the corporation; or

(b) a report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by him.

Although Clément did have a bachelor’s degree in commerce and 15 years of experience in administration and finance with Wise, this experience does not correspond to the level of professionalism required to allow the directors to rely on his advice as a bar to a suit under the duty of care.  The named professional groups in s. 123(4) (b) were lawyers, accountants, engineers, and appraisers.  Clément was not an accountant, was not subject to the regulatory overview of any professional organization and did not carry independent insurance coverage for professional negligence.  The title of vice-president of finance should not automatically lead to a conclusion that Clément was a person “whose profession lends credibility to a statement made by him”.  It is noteworthy that the word “profession” is used, not “position”.  Clément was simply a non-professional employee of Wise.  His judgment on the appropriateness of the solution to the inventory management problem must be regarded in that light.  Although we might accept for the sake of argument that Clément was better equipped and positioned than the Wise brothers to devise a plan to solve the inventory management problems, this is not enough.  Therefore, in our opinion, the Wise brothers cannot successfully invoke the defence provided by s. 123(4) (b) of the CBCA  but must rely on the other defences raised.” (Emphasis added)

Please also read the brief discussion on all this at Note 12 on page 633 of the Casebook. As well please refer to section 157 of the BCBCA:

“157.  (1) A director of a company is not liable under section 154 and has complied with his or her duties under section 142 (1) if the director relied, in good faith, on

(a) financial statements of the company represented to the director by an officer of the company or in a written report of the auditor of the company to fairly reflect the financial position of the company,

(b) a written report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by that person,

(c) a statement of fact represented to the director by an officer of the company to be correct, or

(d) any record, information or representation that the court considers provides reasonable grounds for the actions of the director, whether or not

(i)   the record was forged, fraudulently made or inaccurate, or

(ii)   the information or representation was fraudulently made or inaccurate.

(2) A director of a company is not liable under section 154 if the director did not know and could not reasonably have known that the act done by the director or authorized by the resolution voted for or consented to by the director was contrary to this Act.”

 

Discussion Activity 7.1:

A number of questions present themselves:

1. Consider, in the context of Peoples Department Stores Inc. v. Wise the impact of board meetings by telephone.
2. Are the principles enunciated in Soper v. Canada consistent with those in Peoples Department Stores Inc. v. Wise?
3. Is requiring that a report come from a “professional” before it can be relied on in good faith by directors without potential liability as set out in Peoples Department Stores Inc. v. Wise going too far? What are the core justifications for such a requirement of “professionalism”? Why does that requirement apply to reports in section 123(4)(b) but not to financial statements in section 123(4)(a)

Please consider briefly sharing your views on these questions and your reasons.

 

C. Insider Trading

Please read the short section on “Insider Trading Rules” at page 819-820 of the casebook.

Please read the following relevant provisions of the Securities Act [RSBC 1996] Chapter 418 which provide:

“57.2  (1) In this section, “issuer” means

(a) a reporting issuer, or

(b) any other issuer whose securities are publicly traded.

(2) A person must not enter into a transaction involving a security of an issuer, or a related financial instrument of a security of an issuer, if the person

(a) is in a special relationship with the issuer, and

(b) knows of a material fact or material change with respect to the issuer, which material fact or material change has not been generally disclosed.

(3) An issuer or a person in a special relationship with an issuer must not inform another person of a material fact or material change with respect to the issuer unless

(a) the material fact or material change has been generally disclosed, or

(b) informing the person is necessary in the course of business of the issuer or of the person in the special relationship with the issuer.

(4) A person who proposes to

(a) make a take over bid, as defined in section 92, for the securities of an issuer,

(b) become a party to a reorganization, amalgamation, merger, arrangement or similar business combination with an issuer, or

(c) acquire a substantial portion of the property of an issuer,

must not inform another person of a material fact or material change with respect to the issuer unless

(d) the material fact or material change has been generally disclosed, or

(e) informing the person is necessary to effect the take over bid, business combination or acquisition.

(5) If a material fact or material change with respect to an issuer has not been generally disclosed, the issuer, or a person in a special relationship with the issuer with knowledge of the material fact or material change, must not recommend or encourage another person to enter into a transaction involving a security of the issuer or a related financial instrument of a security of the issuer.

Liability for insider trading, tipping and recommending

136. (1) If an issuer, or a person in a special relationship with an issuer, contravenes section 57.2, a person referred to in subsection (2) of this section has a right of action against the issuer or the person in a special relationship with the issuer.

(2) A person may recover losses incurred in relation to a transaction involving a security of the issuer, or a related financial instrument of a security of the issuer, if the transaction was entered into during the period

(a) starting when the contravention occurred, and

(b) ending at the time the material fact or material change is generally disclosed.

(3) If a court finds a person liable in an action under subsection (1), the amount payable to the plaintiff by the person is the lesser of

(a) the losses incurred by the plaintiff, and

(b) an amount determined in accordance with the regulations.

(4) For the purposes of subsection (1), in determining the losses incurred by a plaintiff, a court must not include an amount that the defendant proves is attributable to a change in the market price of the security that is unrelated to the material change or the material fact.

Accounting for benefits

136.1  (1) If a person is an insider, affiliate or associate of an issuer, and if the person contravenes section 57.2, the person must pay to the issuer an amount equal to

(a) the benefit that the person received as a result of the contravention, and

(b) the benefit that all persons received as a result of the contravention.

(2) If a person contravenes section 57.3, the person must pay to the investor, as defined in that section, an amount equal to

(a) the benefit that the person received as a result of the contravention, and

(b) the benefit that all persons received as a result of the contravention.

Due diligence defence for insider trading

136.2  A person is not liable under section 136 or 136.1 (1) if, after a reasonable investigation occurring before the person

(a) entered into the transaction,

(b) informed another person of the material fact or material change, or

(c) recommended or encouraged a transaction,

the person had no reasonable grounds to believe that the material fact or material change had not been generally disclosed.

Action by commission on behalf of issuer

137. (1) On application by

(a) the commission, or

(b) any person who

(i)  was, at the time of a transaction referred to in section 136, or

(ii)  is, at the time of the application, a security holder of the issuer,

the Supreme Court may, if satisfied that

(c) the applicant has reasonable grounds for believing that the issuer has a cause of action under section 136.1 (1), and

(d) the issuer has

(i)  refused or failed to commence an action under section 136.1 (1) within 60 days after receipt of a written request from the applicant to do so, or

(ii)  failed to prosecute diligently an action commenced by it under section 136.1 (1),

make an order, on any terms as to security for costs or otherwise that it considers proper, requiring the commission or authorizing the person or the commission to commence or continue an action in the name of, and on behalf of, the issuer to enforce the liability created by section 136.1 (1).

(2) On application by

(a) the commission, or

(b) any person who

(i)  was, at the time of a transaction referred to in section 136.1 (2), or

(ii)  is, at the time of the application,

a security holder of the investor, the Supreme Court may, if satisfied that

(c) the applicant has reasonable grounds for believing that the investor has a cause of action under section 136.1 (2), and

(d) the investor has

(i)  refused or failed to commence an action under section 136.1 (2) within 60 days after receipt of a written request from the applicant to do so, or

(ii)  failed to prosecute diligently an action commenced by it under section 136.1 (2),

make an order, on any terms as to security for costs or otherwise that it considers proper, requiring the commission or authorizing the person or the commission to commence or continue an action in the name of, and on behalf of, the investor to enforce the liability created by section 136.1 (2).

(3) If an action under section 136.1 (1) or (2) is commenced or continued by the directors of the issuer, the Supreme Court may order the issuer to pay all costs properly incurred by the directors in commencing or continuing the action, as the case may be, if it is satisfied that the action is in the best interests of the issuer and its security holders.

(4) If an action under section 136.1 (1) or (2) is commenced or continued by a person who is a security holder of the issuer, the Supreme Court may order the issuer to pay all costs properly incurred by the security holder in commencing or continuing the action, as the case may be, if it is satisfied that

(a) the issuer refused or failed to commence the action or, having commenced it, failed to prosecute it diligently, and

(b) the action is in the best interests of the issuer and its security holders.

(5) If an action under section 136.1 (1) or (2) is commenced or continued by the commission, the Supreme Court must order the issuer to pay all costs properly incurred by the commission in commencing or continuing the action, as the case may be.

(6) In determining whether an action or its continuance is in the best interests of an issuer and its security holders, the court must consider the relationship between the potential benefit to be derived from the action by the issuer and its security holders and the cost involved in the prosecution of the action.

(7) Notice of every application under subsection (1) or (2) must be sent to the commission and the issuer, or the investor, as the case may be, and each of them may appear and be heard.

(8) An order made under subsection (1) or (2) requiring or authorizing the commission to commence or continue an action must provide that the issuer or investor, as the case may be,

(a) cooperate fully with the commission in the commencement or continuation of the action, and

(b) make available to the commission all records and other material or information relevant to the action and known to, or reasonably ascertainable by, the issuer or investor.” (Emphasis added)

 

D. Miscellaneous Duties

Please read the section of the Casebook titled “Miscellaneous Statutory Duties” at pages 820-822. This short section deals with particular obligations on managers that are not capable of being sorted or organized in a simple way. It would not be surprising if these sorts of miscellaneous duties and obligations grow as the power of what managers actually do and their compensation continues to grow.

 

TOPIC 2: MANAGERS’ FIDUCIARY OBLIGATIONS

A. Nature & Source

Please carefully read pages 823-830 of the Casebook.

In this context we revisit the case of Peoples Department Stores v. Wise [2004] 3 S.C.R. 461 at pages 618-629 of the Casebook.

Note first the following statutory provisions:

CBCA 122. (1): “Every director and officer of a corporation in exercising their powers and discharging their duties shall (a) act honestly and in good faith with a view to the best interests of the corporation;”

BCBCA 142. (1): “A director or officer of a company, when exercising the powers and performing the functions of a director or officer of the company, as the case may be, must (a) act honestly and in good faith with a view to the best interests of the company,”

Of note are some of the phrases used in the judgment in Peoples Department Stores v. Wise.

At page 623 of the Casebook the “duty of loyalty” is used:

“The first duty has been referred to in this case as the “fiduciary duty”. It is better described as the “duty of loyalty”.

Subsequently at pages 947-948 of the Casebook:

“The statutory fiduciary duty requires directors and officers to act honestly and in good faith vis-à-vis the corporation. They must respect the trust and confidence that have been reposed in them to manage the assets of the corporation in pursuit of the realization of the objects of the corporation.  They must avoid conflicts of interest with the corporation.  They must avoid abusing their position to gain personal benefit.  They must maintain the confidentiality of information they acquire by virtue of their position.  Directors and officers must serve the corporation selflessly, honestly and loyally…” 

Note that the fiduciary duty owed by directors and officers imposes rather strict obligations per Canadian Aero Services Ltd. v. O’Malley, [1974] S.C.R. 592

In the light of this language, what are the components of the duty of loyalty?

Of interest is the following index which form part of the “UK Companies Act 2006 (c.46)”:

“171. Duty to act within powers

172. Duty to promote the success of the company
173. Duty to exercise independent judgment
174. Duty to exercise reasonable care, skill and diligence
175. Duty to avoid conflicts of interest
176. Duty not to accept benefits from third parties
177. Duty to declare interest in proposed transaction or arrangement

183 Offence of failure to declare interest”

Please read the notes at pages 952-955 of the Casebook. Also consider whether you believe there to be any “paradox” between the core fiduciary duty to act in the perceived best interests of one’s beneficiary and the no-conflict and no-profit rules?

 

B To Whom Are Duties Owed?

It is clear from Peoples Department Stores v. Wise that the duty is owed to the corporation, and not for example to creditors. That said what is not yet clear are the methodology and considerations a manager ought to employ when determining what is in “the best interests of the corporation”. How broad may that consideration be? Does it include only “the best interests of the shareholders of the corporation” or does it go beyond to include all of the myriad factors and actors who might be relevant to corporate existence, including creditors and others. In other words even if a fiduciary duty is not owed by a corporate officer to creditors of the corporation, should that corporate officer still consider the position of creditors (and others) in exercising their fiduciary duty “in the best interests of the corporation”. The clear answer seems to be “yes”. As esoteric as this question may sound, it is actually a very practical and common one in the day-to-day exercise of management duties.

 

 C. Judicial Review of Exercise of Managerial Power

Please read pages 771-786 of the Casebook.

 

Please read the decision in Hogg v. Cramphorn Ltd. [1966] 3 All E.R. 420 (Ch.D.) at pages 773-775 of the Casebook.

The board of Cramphorn Ltd. had company shares issued to a trust for the benefit of its employees in order to prevent the take-over of the company.  There was a genuine belief among the board and the chairman and managing director of Cramphorn Ltd., Colonel Cramphorn, that such a take-over was bad for company; that it would change the business and unsettle employees. The Court found the new shares issued by the board to be invalid. The purpose of preventing the takeover, however sincerely motivated, was found not be a valid one, and accordingly the directors had violated their duties by issuing the shares. Buckley J. found that “…The power to issue shares was a fiduciary power and if as I think, it was exercised for an improper motive, the issue of these shares is liable to be set aside…”

 

Please note the contents of BC Standard Articles paragraph 3.1 as they are not dissimilar from the articles in issue in Hogg v. Cramphorn Ltd.

“Subject to the Business Corporations Act and the rights, if any, of the holders of issued shares of the Company, the Company may issue, allot, sell or otherwise dispose of the unissued shares and issued shares held by the Company, at the times, to the persons, including directors, in the manner, on the terms and conditions and for the issue prices (including any premium at which shares with par value may be issued) that the directors may determine. The issue price for a share with par value must be equal to or greater than the par value of the share.”

Please also note that the improper issuance of shares could only be validated if the decision was to be ratified by the shareholders at a general meeting. Validating mistakes and miscue’s through shareholder ratification at a general meeting is actually quite a practical and logical step when you on it. In many situations (though probably not in the case of a takeover bid) it may not even be a necessarily difficult step.

Please consider for yourself the question raised in Note 1 on page 775 of the Casebook.

 

Please read the case of Teck Corp. v. Millar (1972), 33 DLR (3d) 288 (BCSC) at pages 776-782 of the Casebook. The question to ask while reading Teck Corp. v. Millar is why was Hogg v. Cramphorn was not followed by Teck Corp. v. Millar?

 

Similar to Hogg v. Cramphorn, Teck Corp. v. Millar, (1972), 33 DLR (3d) 288 (BCSC) deals the fiduciary duty of corporate directors in the context of a takeover bid.

Teck Corp. argued that the board of Afton Mines Ltd. had entered into a deal with Canadian Exploration Ltd (“Canex”) and Placer Development Ltd. to prevent Teck from gaining control of Afton Mines Ltd. and had thereby acted for an improper purpose. In fact Teck had over time come to acquire a majority of Afton’s shares.   Afton Mines Ltd. argued that it believed it was in the best interests of Afton to make a deal with Canex and not Teck. Accordingly they argued that the board of Afton had acted in that company’s interest despite the adverse effect on Teck, Teck’s shares in Afton, and Teck’s desire to own Afton. The court found that it was unnecessary for the board to act pursuant to a majority shareholder’s wishes in order for it to be acting in the best interests of the company. That applied even if the actions of the board prevented the majority shareholder from taking control of the company.

The court found that the board had a reasonable belief that a deal with Canex was better for the company than would have been a deal with Teck. The board therefore acted in good faith in entering into the agreement with Canex. Accordingly Afton’s actions in hindering Teck’s efforts to obtain control of Afton were not improper. In summary the court concluded that hostile take-overs may be resisted by corporate directors provided they are acting in good faith, and that they have reasonable grounds to believe that the take-over will cause substantial harm to the interests of the company’s shareholders. In the words Berger J. of the BC Supreme Court:

“A classical theory that once was unchallengeable must yield to the facts of modern life. In fact, of course, it has. If today the directors of a company were to consider the interests of its employees no one would argue that in doing so they were not acting bona fide in the interests of the company itself. Similarly, if the directors were to consider the consequences to the community of any policy that the company intended to pursue, and were deflected in their commitment to that policy as a result, it could not be said that they had not considered bona fide the interests of the shareholders.

I appreciate that it would be a breach of their duty for directors to disregard entirely the interests of a company’s shareholders in order to confer a benefit on its employees: Parke v. Daily News Ltd. But if they observe a decent respect for other interests lying beyond those of the company’s shareholders in the strict sense, that will not, in my view, leave directors open to the charge that they have failed in their fiduciary duty to the company.”

Perhaps it is a bit more obtuse then the direct approach taken by the learned trial judge in Teck Corp. v. Millar, but there is a different, more psychological way, the two cases may be rationalized at least somewhat. That is by more closely examining who was being protected and with what intention. In Hogg v. Cramphorn the directors of Cramphorn Ltd. seemed essentially to feel that the takeover was bad for company in that it would change the business and unsettle employees. Thus the best interests of the shareholders might be seen as perhaps being somewhat of a less direct factor in their deliberations. However in Teck v. Millar the interests of the shareholders seems far more of a central factor to the decision making of the board. It is of course a great irony of the somewhat strange fact pattern in Teck v. Millar that Teck was already a majority holder of the shares in the company it was trying to take over – and despite that fact the best interests of the company was not defined by the identity of the majority shareholder of that company’s stock.

 

We now turn to the cases of Parke v. Daily News Ltd. [1962] 2 All ER 92 & Re W & M Roith Ltd. [1967] 1 All ER 427. Please read them:

 

In Parke v. Daily News Ltd. the Daily News Ltd. published two newspapers that were running at a loss over a number of years. The board entered into a contract to sell the newspapers disposing of substantially all company’s assets. The result of the transaction would be the “redundancy” and termination of an overwhelming majority of employees. The directors proposed to use balance of the sale proceeds to provide give compensatory payments to those who were going to lose their jobs. The minority shareholders challenged this saying that such payments would be “ultra vires” the company.

 

Plowman J. quoted Bowen L.J. in Hutton v. West Cork Ry Co (1883), 23 ChD at p 670:

“Bona fides cannot be the sole test, otherwise you might have a lunatic conducting the affairs of the company and paying away its money with both hands in a manner perfectly bona fide yet perfectly irrational. The test must be what is reasonably incidental to, and within the reasonable scope of carrying on, the business of the company.”

Plowman J. went on to say:

“The conclusions which, I think, follow from these cases are: first, that a company’s funds cannot be applied in making ex gratia payments as such; secondly, that the court will inquire into the motives actuating any gratuitous payment, and the objectives which it is intended to achieve; thirdly, that the court will uphold the validity of gratuitous payments if, but only if, after such inquiry it appears that the tests enumerated by Eve J are satisfied; fourthly, that the onus of upholding the validity of such payments lies on those who assert it…

In my judgment, therefore, the defendants were prompted by motives which, however laudable, and however enlightened from the point of view of industrial relations, were such as the law does not recognise as a sufficient justification. Stripped of all its side issues, the essence of the matter is this, that the directors of the defendant company are proposing that a very large part of its funds should be given to its former employees in order to benefit those employees rather than the company, and that is an application of the company’s funds which the law, as I understand it, will not allow. If this is right, then it appears to me to follow from Hutton v West Cork Ry Co that the proposal to pay compensation is one which a majority of shareholders is not entitled to ratify.”

 

In Re W & M Roith Ltd. Mr. Roith, the controlling director had provided many years services to W & M Roith Ltd. without a service contract. He was then given a service agreement providing for payment of a pension to his widow if he died while still a director. Mr. Roith was already in poor health at time of agreement.  He died two months later. The pension was paid for several years and then the company went into liquidation. Mr. Roith’s executors put in a claim in the liquidation for the capitalized value of the pension. The liquidator rejected the claim.

It was held (again by Plowman J.) that the claim for the pension could not be supported. This was because the pension was not for the benefit of the company, nor incidental to the carrying on of the company’s business.

 

CONSIDER THE FOLLOWING TWO QUESTIONS AND THEIR RELATIONSHIP:

 

1. How should charitable and political contributions be treated? Are they for the benefit of the company or the individuals from the company who may want to go to fancy dinners and associate with the powerful or self aggrandize in some other way?
2. As a shareholder how might you reconcile the issue of the fiduciary duties of directors to what is in the best interests of the corporation and the “rights” of the corporation as a corporate person to act in the way it feels is best?

 

Please read the following story from ars technica which can be found here: http://arstechnica.com/apple/2014/03/at-apple-shareholders-meeting-tim-cook-tells-off-climate-change-deniers/

“At Apple shareholder’s meeting, Tim Cook tells off climate change deniers: “If you want me to do things only for ROI reasons, you should get out of this stock.”

by Megan Geuss – Mar 1 2014, 1:30pm PST

Apple’s Maiden, North Carolina data center will be largely powered by Apple’s own solar panel arrays and methane-powered fuel cells.

Apple, Inc.

At a shareholders meeting on Friday, CEO Tim Cook angrily defended Apple’s environmentally-friendly practices against a request from the conservative National Center for Public Policy Research (NCPPR) to drop those practices if they ever became unprofitable.

NCPPR put forward a shareholder’s proposal asking Apple to disclose how much it spends on sustainability programs. If those costs detracted from Apple’s bottom line, the NCPPR demanded that Apple discontinue the programs and commit only to projects that are explicitly profitable. Cook apparently became angry at the group’s request. According to an account from MacObserver:

What ensued was the only time I can recall seeing Tim Cook angry, and he categorically rejected the worldview behind the NCPPR’s advocacy. He said that there are many things Apple does because they are right and just, and that a return on investment (ROI) was not the primary consideration on such issues.

“When we work on making our devices accessible by the blind,” he said, “I don’t consider the bloody ROI.” He said that the same thing about environmental issues, worker safety, and other areas where Apple is a leader.

…

He didn’t stop there, however, as he looked directly at the NCPPR representative and said, “If you want me to do things only for ROI reasons, you should get out of this stock.”

For the better part of the last decade, Apple has taken on a number of sustainability projects and adopted practices to reduce waste and carbon emissions. In 2012, it broke ground on a data centerin Oregon in order to take advantage of low-cost renewable energy and has plans to make all of its facilities reliant on green energy. It generally scores highly with EPEAT, a federal environmental group that keeps a registry of “green” digital devices. And in May 2013, it hired Lisa Jackson, who formerly ran the Environmental Protection Agency, to help Apple with sustainability.

NCPPR later issued a blustery press release about how Apple’s desire to “combat so-called climate change” would destroy shareholder value. It accused “the Al gore contingency in the room” of greeting its questions “with boos and hisses.”

According to the press release, Justin Danhof, director of the National Center’s Free Enterprise Project, said “Mr. Cook made it very clear to me that if I, or any other investor, was more concerned with return on investment than reducing carbon dioxide emissions, my investment is no longer welcome at Apple.”

It seems clear that Apple won’t halt its projects for climate change deniers, and the rest of its shareholders weren’t troubled by that at all. The NCPPR’s proposal received just 2.95 percent of the vote.”

 

Discussion Activity 7.2:

Assume Apple is a Canadian company and you are their counsel. Do you have any advice for Mr. Cook regarding his view of corporate ethics in a company law context?

Please consider briefly sharing your advice and your reasons as they may relate to the earlier two questions set out above and the subject of“Social Responsibility & Legal Duty” generally.

 

D: Conflicts of Interest and Duty

 

Please read pages 965-979 of the Casebook.

There you will find that the strict principle respecting conflicts of interest was set out as follows in the 1854 decision of Aberdeen Railway Co. v. Blaikie Bros. [1843-60] All E.R. Rep 249:

“A corporate body can only act by agents, and it is of course the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application, that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect. So strictly is this principle adhered to, that no question is allowed to be raised as to the fairness or unfairness of a contract so entered into. It obviously is, or may be, impossible to demonstrate how far in any particular case the terms of such a contract have been the best for the interest of the cestui que trust, which it was possible to obtain. It may sometimes happen that the terms on which a trustee has dealt or attempted to deal with the estate or interest of those for whom he is a trustee, have been as good as could have been obtained from any other person – they may even at the time have been better. But still so inflexible is the rule that no inquiry on that subject is permitted…”

Then please read the second full-paragraph paragraph on page 966 of the Casebook.

Then please turn to and read North-West Transportation Co. v. Beatty (1887), 12 App. Cas. 589 (Ont. J.C.P.C.) at pages 971-973 of the Casebook.

The facts were that James H. Beatty, one of the directors of the North-West Transportation Co. sold that company a ship that he owned.  The shareholders, including James H. Beatty, voted to approve transaction. However another director of the North-West Transportation Co., Henry Beatty, sued the North-West Transportation Co. and certain defendant directors on behalf of himself and all other shareholders to set aside the sale.

The following general principles emerge from the case:

• A vote of the majority of the shareholders on some issue as to which they are competent binds the minority and the corporation.
• A shareholder’s vote is not disqualified by a private interest being at stake.
• So in the absence of fraud or oppression a breach of director’s duty to avoid conflict can be “ratified” by a majority of shareholders including the vote of the conflicted director.

Two points worthy of note about this case.

First it is worthy of mention that the court makes a clear distinction between the conflicted party as a director exercising their rights as a director and the same individual exercising their shareholder rights. Mr. J.H. Beatty quite rightly was absent from the directors meeting that approved the transaction. Accordingly his vote as a director was never made or considered in the equation. However Mr. Beatty did vote his shares as shareholder to ratify the directors’ decision and that was judged to be perfectly valid by the Judicial Committee of the Privy Council (though not by the court below). This is an excellent illustration of how the roles of directors and shareholders are – at least in theory.

Secondly, apart from the point immediately above the principles set out in the case would appear to constitute rather austere rules for what is often a very complex (and even unavoidable) subject in the “real world”.

 

Discussion Activity 7.3:

All of this raises the question of to whom did James H. Beatty owe a duty?  Did the shareholder vote relieve him of that duty?  How or why would that be? Could the North-West Transportation Co. Have maintained contract with James H. Beatty and also have sued to recover any profit he benefitted from as a result of the transaction?

Please consider briefly sharing your views on these questions and your reasons as they relate to “Conflict of Interest and Duty”.

 

E. Statutory Conflict of Interest Protocols

Section 147 and following of the BCBCA essentially create a code of the procedures that must be followed to avoid the application of the strict conflict of interest rules set out above and define the consequences of a failure to do so. The protocol is that the board of directors may approve a transaction in which a director has a “disclosable interest” if the interest has in fact been disclosed. However the interested director may not vote on any such approval resolution per section 149 of the BCBCA. If a director fails to disclose his or her interest in a transaction, the director may be liable to account to the company for any profit he or she receives per section 149 of the BCBCA.

 

What is a “Disclosable Interest”? Section 147 (1) helps us:

“147 (1) For the purposes of this Division, a director or senior officer of a company holds a disclosable interest in a contract or transaction if

(a) the contract or transaction is material to the company,

(b) the company has entered, or proposes to enter, into the contract or transaction, and

(c) either of the following applies to the director or senior officer:

(i)  the director or senior officer has a material interest in the contract or transaction;

(ii)  the director or senior officer is a director or senior officer of, or has a material interest in, a person who has a material interest in the contract or transaction.” (Emphasis added)

Note that neither what is “material to the company” nor what is a “material interest” is actually defined.

In the case of Zysko v. Thorarinson, 2003 ABQB 911 the Honourable Mr. Justice P. Chrumka, quoted (inter alia), Professor B.L. Welling from Corporate Law in Canada: The Governing Principles, 2nd ed. (Vancouver: Butterworths, 1991), on the issue of what interests are “material”:

“…it seems clear that the statute also addresses the problem of a director or officer who has no monetary interest in a person on the other side, yet who is likely to have an emotional involvement. Thus, a deal in which the corporation is negotiating with a close relative, or even a close personal friend, of one of the directors or officers ought to be suspect. …one can assume that the courts will address their attention to the blood relation question… the only question will be to what degree of relationship the section extends. The answer is once again, subsumed under the requirement that the interest itself be “material”.

What is meant by “material”… In the context of conflict of interest contracts, the meaning of “material contract” and “material interest” is conditioned by the purpose behind the section. The purpose is to identify those negotiations in which a corporate manager’s ability to bargain effectively on behalf of the corporation may be inhibited by some interest he has in the other side. Any personal relationship or monetary interest he may have in the other side that might be thought to be an inhibiting factor is a material interest if disclosure of the relationship or interest might be relevant to the corporate decision whether to involve the particular manager in the negotiations. Whether to participate in a proposed contract is a corporate decision and the corporation is entitled to full disclosure from its fiduciaries of all facts that might affect that decision.” (Emphasis added)

 

The full decision in Zysko v. Thorarinson can be found here: http://caselaw.canada.globe24h.com/0/0/alberta/court-of-queen-s-bench/2003/11/07/zysko-v-thorarinson-2003-abqb-911.shtml

Zysko v. Thorarinson was approved in Mikulic v Peter, 2013 BCSC 941 (BCSC).

Finally please note the “notice exclusions” from disclosable interest in sections 147 (2) and (4) of the BCBCA as well as the approval mechanism after disclosure in BCBCA section149. For your convenience the relevant provisions are reproduced below:

 

“Division 3 — Conflicts of Interest

Disclosable interests

147. (1) For the purposes of this Division, a director or senior officer of a company holds a disclosable interest in a contract or transaction if

(a) the contract or transaction is material to the company,

(b) the company has entered, or proposes to enter, into the contract or transaction, and

(c) either of the following applies to the director or senior officer:

(i)   the director or senior officer has a material interest in the contract or transaction;

(ii)   the director or senior officer is a director or senior officer of, or has a material interest in, a person who has a material interest in the contract or transaction.

(2) For the purposes of subsection (1) and this Division, a director or senior officer of a company does not hold a disclosable interest in a contract or transaction if

(a) the situation that would otherwise constitute a disclosable interest under subsection (1) arose before the coming into force of this Act or, if the company was recognized under this Act, before that recognition, and was disclosed and approved under, or was not required to be disclosed under, the legislation that

(i)   applied to the corporation on or after the date on which the situation arose, and

(ii)   is comparable in scope and intent to the provisions of this Division,

(b) both the company and the other party to the contract or transaction are wholly owned subsidiaries of the same corporation,

(c) the company is a wholly owned subsidiary of the other party to the contract or transaction,

(d) the other party to the contract or transaction is a wholly owned subsidiary of the company, or

(e) the director or senior officer is the sole shareholder of the company or of a corporation of which the company is a wholly owned subsidiary.

(3) In subsection (2), “other party” means a person of which the director or senior officer is a director or senior officer or in which the director or senior officer has a material interest.

(4) For the purposes of subsection (1) and this Division, a director or senior officer of a company does not hold a disclosable interest in a contract or transaction merely because

(a) the contract or transaction is an arrangement by way of security granted by the company for money loaned to, or obligations undertaken by, the director or senior officer, or a person in whom the director or senior officer has a material interest, for the benefit of the company or an affiliate of the company,

(b) the contract or transaction relates to an indemnity or insurance under Division 5,

(c) the contract or transaction relates to the remuneration of the director or senior officer in that person’s capacity as director, officer, employee or agent of the company or of an affiliate of the company,

(d) the contract or transaction relates to a loan to the company, and the director or senior officer, or a person in whom the director or senior officer has a material interest, is or is to be a guarantor of some or all of the loan, or

(e) the contract or transaction has been or will be made with or for the benefit of a corporation that is affiliated with the company and the director or senior officer is also a director or senior officer of that corporation or an affiliate of that corporation.

 

Obligation to account for profits

148. (1) Subject to subsection (2) and unless the court orders otherwise under section 150 (1) (a), a director or senior officer of a company is liable to account to the company for any profit that accrues to the director or senior officer under or as a result of a contract or transaction in which the director or senior officer holds a disclosable interest.

(2) A director or senior officer of a company is not liable to account for and may retain the profit referred to in subsection (1) of this section in any of the following circumstances:

(a) the disclosable interest was disclosed before the coming into force of this Act under the former Companies Act that was in force at the time of the disclosure, and, after that disclosure, the contract or transaction is approved in accordance with section 149 of this Act, other than section 149 (3);

(b) the contract or transaction is approved by the directors in accordance with section 149, other than section 149 (3), after the nature and extent of the disclosable interest has been disclosed to the directors;

(c) the contract or transaction is approved by a special resolution in accordance with section 149, after the nature and extent of the disclosable interest has been disclosed to the shareholders entitled to vote on that resolution;

(d) whether or not the contract or transaction is approved in accordance with section 149,

(i)   the company entered into the contract or transaction before the director or senior officer became a director or senior officer of the company,

(ii)   the disclosable interest is disclosed to the directors or the shareholders, and

(iii)   the director or senior officer does not participate in, and, in the case of a director, does not vote as a director on, any decision or resolution touching on the contract or transaction.

(3) The disclosure referred to in subsection (2) (b), (c) or (d) of this section must be evidenced in a consent resolution, the minutes of a meeting or any other record deposited in the company’s records office.

(4) A general statement in writing provided to a company by a director or senior officer of the company is a sufficient disclosure of a disclosable interest for the purpose of this Division in relation to any contract or transaction that the company has entered into or proposes to enter into with a person if the statement declares that the director or senior officer is a director or senior officer of, or has a material interest in, the person with whom the company has entered, or proposes to enter, into the contract or transaction.

(5) In addition to the records that a shareholder of the company may inspect under section 46, that shareholder may, without charge, inspect

(a) the portions of any minutes of meetings of directors, or of any consent resolutions of directors, that contain disclosures under this section, and

(b) the portions of any other records that contain those disclosures.

(6) In addition to the records a former shareholder of the company may inspect under section 46, that former shareholder may, without charge, inspect the records referred to in subsection (5) (a) and (b) of this section that are kept under section 42 and that relate to the period when that person was a shareholder.

(7) Sections 46 (7) and (8), 48 (1) and (3) and 50 apply to the portions of minutes, resolutions and records referred to in subsections (5) and (6) of this section.

 

Approval of contracts and transactions

149. (1) A contract or transaction in respect of which disclosure has been made in accordance with section 148 may be approved by the directors or by a special resolution.

(2) Subject to subsection (3), a director who has a disclosable interest in a contract or transaction is not entitled to vote on any directors’ resolution referred to in subsection (1) to approve that contract or transaction.

(3) If all of the directors have a disclosable interest in a contract or transaction, any or all of those directors may vote on a directors’ resolution to approve the contract or transaction.

(4) Unless the memorandum or articles provide otherwise, a director who has a disclosable interest in a contract or transaction and who is present at the meeting of directors at which the contract or transaction is considered for approval may be counted in the quorum at the meeting whether or not the director votes on any or all of the resolutions considered at the meeting.

 

Powers of court

150. (1) On an application by a company or by a director, senior officer, shareholder or beneficial owner of shares of the company, the court may, if it determines that a contract or transaction in which a director or senior officer has a disclosable interest was fair and reasonable to the company,

(a) order that the director or senior officer is not liable to account for any profit that accrues to the director or senior officer under or as a result of the contract or transaction, and

(b) make any other order that the court considers appropriate.

(2) Unless a contract or transaction in which a director or senior officer has a disclosable interest has been approved in accordance with section 148 (2), the court may, on an application by the company or by a director, senior officer, shareholder or beneficial owner of shares of the company, make one or more of the following orders if the court determines that the contract or transaction was not fair and reasonable to the company:

(a) enjoin the company from entering into the proposed contract or transaction;

(b) order that the director or senior officer is liable to account for any profit that accrues to the director or senior officer under or as a result of the contract or transaction;

(c) make any other order that the court considers appropriate.

 

Validity of contracts and transactions

151. A contract or transaction with a company is not invalid merely because

(a) a director or senior officer of the company has an interest, direct or indirect, in the contract or transaction,

(b) a director or senior officer of the company has not disclosed an interest he or she has in the contract or transaction, or

(c) the directors or shareholders of the company have not approved the contract or transaction in which a director or senior officer of the company has an interest.

 

Limitation of obligations of directors and senior officers

152. Except as is provided in this Division, a director or senior officer of a company has no obligation to

(a) disclose any direct or indirect interest that the director or senior officer has in a contract or transaction, or

(b) subject to section 192, account for any profit that accrues to the director or senior officer under or as a result of a contract or transaction in which the director or senior officer has a disclosable interest.

 

Disclosure of conflict of office or property

153. (1) If a director or senior officer of a company holds any office or possesses any property, right or interest that could result, directly or indirectly, in the creation of a duty or interest that materially conflicts with that individual’s duty or interest as a director or senior officer of the company, the director or senior officer must disclose, in accordance with this section, the nature and extent of the conflict.

(2) The disclosure required from a director or senior officer under subsection (1)

(a) must be made to the directors promptly

(i)   after that individual becomes a director or senior officer of the company, or

(ii)   if that individual is already a director or senior officer of the company, after that individual begins to hold the office or possess the property, right or interest for which disclosure is required, and

(b) must be evidenced in one of the ways referred to in section 148 (3).”

 

Discussion Activity 7.4:

All of which leaves us with a rather vexing question. If the rather austere and harsh rules set rule in in the 1854 decision of Aberdeen Railway Co. v. Blaikie Bros. Have been mitigated by statute when it comes to “material” conflicts of interest, what are we to conclude with respect to “non-material” contracts or transactions? They are not mentioned in the statute. Are “non-material” contracts or transactions then subject to the rules set out in Aberdeen Railway Co. v. Blaikie Bros.? Would this make any sense?

Please consider your views on these questions and your reasons. Please share them if you would like to.

 

F. Corporate Opportunities

Please review pages 979-1071 of the Casebook.

The Canadian case of Cook v. Deeks  [1916] 1 A.C. 554 (Ont. J.C.P.C.) provides a useful fact pattern from which to proceed.

The facts were that the Toronto Construction Co. (“TCC”) had four shareholders (each holding a quarter of the company’s shares) each of whom who were also the directors of that company. TCC helped with railway construction for the CPR. Three of the directors wanted to exclude the fourth, Mr. Cook, from the business and accordingly agreed to a contract with the CPR for building a line at the Guelph Junction and Hamilton branch in their own three names, and not in the name of TCC. They then passed a shareholder resolution declaring that the company had no interest in that contract between the three and the CPR. Mr. Cook sued arguing that the contract did indeed belong to the Toronto Construction Co. and that the shareholder resolution ratifying the actions of the three other shareholder directors was not valid.

The Judicial Committee of the Privy Council found that the three directors had breached their duty of loyalty to the company. Perhaps the more challenging point was how the court would deal with the issue of the shareholder ratification that had occurred given their previous decision in North-West Transportation v. Beatty (1887), 12 APP. CAS. 589 (ONT. J.C.P.C.) where it was decided that in the absence of fraud or oppression a breach of director’s duty to avoid conflict can be “ratified” by a majority of shareholders including the vote of the conflicted director. The Judicial Committee of the Privy Council accomplished feat in Cooks v. Deeks by drawing a distinction between contracting with the corporation as was the case in North-West Transportation v. Beatty (where Mr. Beatty was selling his boat to North-West Transportation), and contracting outside the corporation as was the case in Cook v. Deeks (where TCC was not directly involved in the transaction). Does this really make sense on a principled basis, or is it a “distinction without a difference”?

In the end the three director/shareholders had to account to TCC for the profits they had made on the contractual opportunity, and those were held in trust for the Toronto Construction Co. (of which you will recall Mr. Cook had a one-quarter interest).

Please read the fascinating case of Regal (Hastings) Ltd. v. Gulliver [1942] 1 All E.R. 378 at pages 1005-1009 of the Casebook which deals with what happens when directors (and a lawyer) acting in good faith and in the best interests of their company follow through personally on a “corporate opportunity”.  The entire case can be found here: http://www.bailii.org/uk/cases/UKHL/1942/1.html

In this case the defendants were the directors of Regal (Hastings) Ltd., a company which operated a movie theatre. Regal (Hastings) Ltd. created Hastings Amalgamated Cinemas Limited, intending it to be a subsidiary to acquire two nearby movie theatres the Elite and the De Luxe.

Because of a lack of money at the time in Regal (Hastings) Ltd., the directors and solicitors of Regal (Hastings) Ltd. personally paid for 60% of the shares in Hastings Amalgamated Cinemas Limited. Regal (Hastings) Ltd. had the remaining 40%. Please note that “it was assumed throughout that the defendants acted in the best interests of Regal” as stated at the bottom of the note introducing the case and which appears at page 365 of the Casebook.

Ultimately the shares in Regal (Hastings) Ltd. and the 3,000 shares in Hastings Amalgamated Cinemas Limited not owned by Regal (Hastings) Ltd. were sold to Oxford & Berkshire Cinemas Ltd. Part of the consideration was for the 3,000 shares Hastings Amalgamated Cinemas Limited not owned by Regal (Hastings) Ltd. and as a result, the defendants (the directors and solicitors of Regal (Hastings) Ltd. who personally paid for 60% of the shares in Hastings Amalgamated Cinemas Limited) made a profit.

Oxford & Berkshire Cinemas Ltd. now in control of Regal (Hastings) Ltd., causes Regal (Hastings) Ltd. to sue its former directors seeking an account of profits made on the sale of their personal shares in Hastings Amalgamated Cinemas Limited.

As an aside, leading counsel for the defendant Gulliver was Denning, Q.C.

The House of Lords reversed the High Court and the Court of Appeal, finding that the defendants had profited “by reason of the fact that they were directors of Regal and in the course of the execution of that office”. Accordingly they were made to account for their profits to Regal (Hastings) Ltd. and therefore ultimately to Oxford & Berkshire Cinemas Ltd.

Per Lord Russell:

“The rule of equity which insists on those who by use of a fiduciary position make a profit, being liable to account for that profit, in no way depends on fraud, or absence of bona fides; or upon questions or considerations as whether the property would or should otherwise have gone to the plaintiff, or whether he took a risk or acted as he did for the benefit of the plaintiff, or whether the plaintiff has in fact been damaged or benefited by his action. The liability arises from the mere fact of a profit having in the stated circumstances been made…

In the result I am of opinion that the directors standing in a fiduciary relationship to Regal in regard to the exercise of their powers as directors, and having obtained these shares by reason and only by reason of the fact that they were directors of Regal and in the course of the execution of that office, are accountable for the profits which they have made out of them. The equitable rule laid down in Keech v. Sandford, ex parte James and similar authorities applies to them in full force. It was contended that these cases were distinguishable by reason of the fact that it was impossible for Regal to get the shares owing to lack of funds, and that the directors in taking the shares were really acting as members of the public. I cannot accept this argument. It was impossible for the cestui quo trust in Keech v. Sandford to obtain the lease, nevertheless the trustee was accountable: and the suggestion that the directors were applying simply as members of the public is a travesty of the facts. They could, had they wished, have protected themselves by a resolution (either antecedent or subsequent) of the Regal share-holders in general meeting. In default of such approval, the liability to account must remain.”

Per Lord Wright: “The Court of Appeal held that, in the absence of any dishonest intention, or negligence, or breach of a specific duty to acquire the shares for the appellant company, the respondents as directors were entitled to buy the shares themselves. Once, it was said, they came to a bona fide decision that the appellant company could not provide the money to take up the shares, their obligation to refrain from acquiring those shares for themselves came to an end. With the greatest respect, I feel bound to regard such a conclusion as dead in the teeth of the wise and salutary rule so stringently enforced in the authorities. It is suggested that it would have been mere quixotic folly for the four respondents to let such an occasion pass when the appellant company could not avail itself of it; Lord King, L.C., faced that very position when he accepted that the person in the fiduciary position might be the only person in the world who could not avail himself of the opportunity.”

Per Lord Porter: “In these circumstances it is to my mind immaterial that the directors saw no way of raising the money save from amongst themselves and from the solicitor to the company, or indeed that the money could in fact have been raised in no other way. The legal proposition may, I think, be broadly stated by saying that one occupying a position of trust must not make a profit which he can acquire only by use of his fiduciary position, or if he does he
must account for the profit so made. For this proposition the cases
of Keech v. Sandford (1726), Sel. Cas. Temp. King. 61, and exparte
James (1803) 8 Ves. jun. 337 are sufficient authority…

… To treat the problem in this way is, in my view, to look at it as involving a claim for negligence or misfeasance and to neglect the wider aspect. Directors, no doubt, are not trustees, but they occupy a fiduciary position towards the company whose board they form. Their liability in this respect does not depend upon breach of duty but upon the proposition that a director must not make a profit out of property acquired by reason of his relationship to the company of which he is director. It matters not that he could not have acquired the property for the company itself—the profit which he makes is the company’s, even though the property by means of which he made it was not and could not have, been acquired on its behalf. Adopting the words of Lord Eldon in ex parte James (supra), ” the general interests of justice require it, “as no Court is equal to the examination and ascertainment of the truth in much the greater number of cases.”

 

Discussion Activity 7.5:

In this way the court chose to affirm the duty of good faith and in effect embrace the strict principle respecting conflicts of interest set out Aberdeen Railway Co. v. Blaikie Bros. (though that case is never directly mentioned). Perhaps this makes sense if you consider that no matter what may be the conscious or stated intention, a directors’ subjective judgement may well be (subconsciously) clouded by the existence of a countervailing interest, usually that of self-interest.

Was this the right answer?

We might begin by wondering what was the practical effect of the decision? It was that the ultimate purchaser of the companies (Oxford & Berkshire Cinemas Ltd.)  Effectively received a rebate of their purchase price. Is this result a concern? Is it logical? How is it that something seemed perfectly legitimate (even necessary and desirable) when done by Regal (Hastings) Ltd., which apparently created value for Regal (Hastings) Ltd. And which arguably could have been done in no other way, can be revisited ex post facto in this way? Should regal be denied a claim just because its shareholders change? Why should the effects of corporate personality distort the general law of fiduciary duties?

Please consider briefly sharing your views on these questions and your reasons.

 

Lord Russell concluded his judgment in Regal (Hastings) Ltd. v. Gulliver with the following statement:

“One final observation I desire to make. In his judgment the
Master of the Rolls stated that a decision adverse to the directors
in the present case involved the proposition that if directors bona
fide decide not to invest their company’s funds in some proposed
investment, a director who thereafter embarks his own money
therein is accountable for any profits which he may derive there-
from. As to this, I can only say that to my mind the facts
of this hypothetical case bear but little resemblance to the story
with which we have had to deal.”

 

We now come to a case that renders the hypothetical real.

Please read Peso Silver Mines v. Cropper [1966] S.C.R. 673 at pages 1010-1012 of the Casebook.

The facts were that a prospector, Mr. Dickson, owned a number of mineral claims one of which was adjacent to claims held by Peso Silver Mines. Mr. Dickson offered to sell them to Peso silver mines, but the offer was rejected by the Peso Silver Mines board. Subsequently, three other investors approached Mr. Cropper who was the managing director of Peso Silver Mines and member of its board, and the four of them formed a private company that acquired Mr. Dickson’s claims and developed them. Later still, control of Peso Silver Mines changed hands and the newly reconstituted Peso Silver Mines sued Mr. Cropper seeking to purchase his holdings in the now profitable mine at Mr. Cropper’s cost, or to account for the proceeds of the transaction.

Significantly the defendants in Peso Silver Mines v. Cropper had acted entirely in good faith in connection with the board’s decision not to pursue an opportunity. Therefore the Supreme Court of Canada found that they could arrange for their own separate company to take the opportunity represented by Mr. Dickson’s claims perfectly lawfully. And they could keep the resulting profits. There had been a valid rejection of a business opportunity by Peso Silver Mines (as it was then controlled), subject to procedural constraints, and which the board in good faith duly exercised. Accordingly a director acting in his personal capacity could take the opportunity perfectly lawfully at a later time.

Cartwright J. stated:

“On the facts of the case at bar I find it impossible to say that the respondent obtained the interests he holds in Cross Bow and Mayo by reason of the fact that he was a director of the appellant and in the course of the execution of that office. When Dickson, at Dr. Aho’s suggestion, offered his claims to the appellant it was the duty of the respondent as director to take part in the decision of the board as to whether that offer should be accepted or rejected. At that point he stood in a fiduciary relationship to the appellant. There are affirmative findings of fact that he and his co-directors acted in good faith, solely in the interests of the appellant and with sound business reasons in rejecting the offer. There is no suggestion in the evidence that the offer to the appellant was accompanied by any confidential information unavailable to any prospective purchaser or that the respondent as director had access to any such information by reason of his office. When, later, Dr. Aho approached the appellant it was not in his capacity as a director of the appellant, but as an individual member of the public whom Dr. Aho was seeking to interest as a co-adventurer.”

Are Peso Silver Mines v. Cropper and Regal (Hastings) Ltd. v. Gulliver really that similar? In Regal (Hastings) Ltd. v. Gulliver all of Regal (Hastings) Ltd.’s directors were interested in the relevant opportunity. They could not have passed a board resolution that would effectively waive the opportunity and so allow the directors to take it for their own benefit. Since they were all interested parties there would not have been anyone to pass such a resolution – all of the directors would have had to be “outside the room”. In Peso Silver Mines v. Cropper there was a fully functioning board that could do and did do their job.

 

Please read the case of Industrial Development Consultants Ltd. v. Cooley [1972] 2 All E.R. 162 (Eng. Birmingham Assizes) at pages 1024-1029 of the Casebook.

Mr. Cooley was a distinguished architect who was employed as the managing director of Industrial Development Consultants Ltd., the plaintiff. Mr. Cooley tried on behalf of Industrial Development Consultants Ltd. to negotiate a contract in respect of lucrative pending project to design a depot in Letchworth with the Eastern Gas Board. The negotiation was unsuccessful and Eastern Gas Board advised Mr. Cooley that they did not want to contract with Industrial Development Consultants Ltd., but only with him. Mr. Cooley then told the board of Industrial Development Consultants Ltd., that he was unwell and asked to resign from his job on early notice. The board of Industrial Development Consultants Ltd. agreed to this request and accepted Mr. Cooley’s resignation. Mr. Cooley then took on the work of design a depot in Letchworth for the Eastern Gas Board on his own account. Industrial Development Consultants Ltd. subsequently discovered this and sued Mr. Cooley for breach of his duty of loyalty.

Mr. Cooley was found liable.  Why? There were a number of reasons that emerge from the case:

• When Mr. Cooley acquired knowledge of the Eastern Gas Board interest in him as the designer of the depot in Letchworth, Industrial Development Consultants Ltd. did not have that knowledge and would have wanted it.
• The information came to Mr. Cooley at a time when Mr. Cooley had only one single capacity – as a director of Industrial Development Consultants Ltd.
• The information was of interest to Industrial Development Consultants Ltd. and Mr. Cooley had the obligation to pass it on.
• The fact that Industrial Development Consultants Ltd. could not or would not have obtained the benefit (i.e. because the Eastern Gas Board would not have been willing to deal with Industrial Development Consultants Ltd.) is irrelevant.
• It is irrelevant that if Mr. Cooley is found liable to Industrial Development Consultants Ltd. the net effect would be that Industrial Development Consultants Ltd. would obtain a benefit that, by definition, it could not otherwise have obtained – authority for this being found in Regal (Hastings) Ltd. v. Gulliver as well as subsequent cases.

Please read the English translation of the decision in Gravino v. Enerchem Transport Inc.  [2008] J.Q. NO 9347 (QUE. C.A.) at pages 1055-1067 of the Casebook. You can find the full decision in French here if that is in any way helpful to you: http://www.canlii.org/fr/qc/qcca/doc/2008/2008qcca1820/2008qcca1820.html

The facts were that a company called Ultramar began negotiations with Enerchem Transport Inc. (“ETI”), for the subchartering by ETI of three Ultramar tankers. Nicholas Gravino and Richard Carson were at the time shareholders and directors of ETI and actively participated in the negotiations with Ultramar. No agreement was reached. Subsequently Mr. Gravino and Mr. Carson sold their ETI shares and a few months later they ended their employment with ETI. For a variety for reasons not directly relevant Mr. Gravino and Mr. Carson were not bound by a non-compete clause. Following their departure, Mr. Gravino and Mr. Carson founded Petro-Nav Inc., a company that competed directly with ETI. They also recruited from ETI its then vice president marketing, Marian Zaremba, to join Petro-Nav Inc. Almost a year later, Ultramar assigned its lease agreement over the tankers Mr. Gravino and Mr. Carson had previously attempted to negotiate for while directors and shareholders of ETI, to a subsidiary of Petro-Nav Inc.

ETI alleged that its former directors and officers had appropriated to themselves a business opportunity they had developed on behalf of their former employer, and that accordingly Mr. Gravino and Mr. Carson had breached their duty of loyalty to ETI.

The reasons for judgment in this case are not exceptionally helpful except, perhaps, as to:

• Duty of loyalty owed to ETI by its ex-officers in this case was all the greater given the high level of responsibility associated with the positions they had held in ETI.
• On the topic of a “maturing business opportunity” it is clear that a director cannot use for their own profit or that of a third party any information obtained by reason of their duties, unless authorized to do so.
• In effect, four main factors must be weighed in order to determine whether misappropriation of a maturing business opportunity has taken place:

1. i) the degree to which the interests of the director and the interests of the company were in conflict,
2. ii) the degree to which the business opportunity had, at the time in question, acquired its own specific and identifiable character,

iii) the proximity in time between the emergence of the business opportunity and its exploitation, and

1. iv) the proximity in character between the business opportunity pursued by the company and the contract or business concluded by the director for his own profit or the profit of a third party.

Please read the excerpts from D.D. Prentice and J. Payne on “The Corporate Opportunity Doctrine” at pages 1069-1071 of the Casebook. This article represents a succinct and important summary of the application of the duty of loyalty to corporate opportunities.

As you have perhaps come to appreciate the three most important factors when it comes to the application of the duty of loyalty to corporate opportunities are:

• The facts;
• The facts; and
• The facts.

 

G. Conflict of Duty and Duty

Please read pages 1141-1146 of the Casebook.

As you will see the issue of having duties of loyalty to two different companies of which one is a board member is not unknown. Nor, apart from resignation from one the companies with competing interests, and possibly both depending on the circumstances, does it have easy solutions. The most useful and prophylactic strategic mechanism is to employ the principle of “informed consent” as liberally as possible. This could go even as far as obtaining written acknowledgment and form of waiver from the companies respecting any potential conflict (much as lawyers must when they are asked to advise different parties who might have divergent interests in the same matter).

 

H. Ratification

Please read pages 1165-1175 of the Casebook.

Ratification by the shareholders is a tool often used to retroactively remedy mistakes that have been made. You will recall the case of Regal (Hastings) Ltd. v. Gulliver where the directors and solicitors of Regal (Hastings) Ltd., acting indisputably in the best interests of Regal (Hastings) Ltd., personally paid for 60% of the shares to acquire two movie houses because Regal (Hastings) Ltd. did not at the time have the funds to do so. In that case Lord Russell observed that the directors “could, had they wished, have protected themselves by a resolution (either antecedent or subsequent) of the Regal shareholders in general meeting.” (Emphasis added)

Also relevant are the words of Harman L.J. in Bamford v. Bamford [1969] 1 All E.R. 969 (C.A.):

“It is trite law, I had thought, that if directors do acts, as they do every day, especially in private companies, which, perhaps because there is no quorum, or because their appointment was defective, or because some- times there are no directors properly appointed at all, or because they are actuated by improper motives, they go on doing for years, carrying on the business of the company in the way in which, if properly constituted, they should carry it on, and then they find that everything has been so to speak wrongly done because it was not done by a proper board, such directors can, by making a full and frank disclosure and calling together the general body of the shareholders, obtain absolution and forgiveness of their sins; and provided the acts are not ultra vires the company as a whole everything will go on as if it had been all right from the beginning. I cannot believe that is not a commonplace of company law. It is done every day. Of course, if the majority of the general meeting will not forgive and approve, then the directors must pay for it.”

Note as well the statutory provisions relevant to the question of ratification whereby evidence of shareholder approval is admissible but not decisive. BCBCA section 233(6) and CBCA Section 242 of the CBCA provide as follows:

233. (6) No application made or legal proceeding prosecuted or defended under section 232 or this section may be stayed or dismissed merely because it is shown that an alleged breach of a right, duty or obligation owed to the company has been or might be approved by the shareholders of the company, but evidence of that approval or possible approval may be taken into account by the court in making an order under section 232 or this section.

242. (1) An application made or an action brought or intervened in under this Part shall not be stayed or dismissed by reason only that it is shown that an alleged breach of a right or duty owed to the corporation or its subsidiary has been or may be approved by the shareholders of such body corporate, but evidence of approval by the shareholders may be taken into account by the court in making an order…”

 

TOPIC 3: TAKE-OVER BIDS AND DEFENSIVE TACTICS

Please read the notes at pages 1202-1204 of the Casebook.

The (multi-million dollar 😉 question is what is the duty of directors to their corporation when confronted with a take-over? And do the directors owe any duties to shareholders?

In this regard please read the case of Olympia and York Enterprises Ltd.  v. Hiram Walker Resouces Ltd.  (1986), 59 O.R. (2d) 254 (H.C.J.) at pages 1204-1208 of the Casebook.

The facts are that Gulf Canada decided it wished to acquire a majority shareholder interest in Hiram Walker Resources Ltd. It offered $32 per share for 39% of the shares. The directors of Hiram Walker Resources Ltd. decide to employ a defensive tactic to stop Gulf Canada by selling the liquor business of Hiram Walker Resources Ltd. representing 40% of the company’s total assets to Allied Lyons plc for $2.6 billion.  Hiram Walker Resources Ltd. used that money to pay for 49% of the shares in a new subsidiary, “Fingas” which then proceeds to bid $40 per share for 48% of Hiram Walker Resources Ltd. (a significant improvement in price and percentage over the Gulf Canada bid).

Olympia &York Enterprises Ltd. was the parent company of Gulf Canada and sought to enjoin sale of the liquor business of Hiram Walker Resources Ltd. to Allied Lyons plc. They argued that the directors of Hiram Walker Resources Ltd. were using corporate assets for the purpose of entrenching themselves in the management of the corporation, and accordingly were in breach of their fiduciary duties.

Montgomery J. dismissed the application of Olympia &York Enterprises Ltd.

On the question of whether the directors proposed to buy back the shares of Hiram Walker Resources Ltd. with corporate assets so as to entrench themselves the court answered in the negative. Montgomery J. found that on the evidence the directors acted prudently, properly, reasonably and fairly on the advice of their legal and financial advisors, the opinion of management and their collective store of business acumen. It was also seen as a legitimate objective to ensure that as much as possible of all “economic value” be distributed to all of the shareholders and not just Gulf Canada/Olympia & York Enterprises Ltd. Montgomery J. said: “I am satisfied on the basis of the affidavits of Mr. Downing and Mr. Lambert that the sole purpose of the conduct of the directors of Hiram Walker was to maximize the position of all their shareholders after Gulf’s takeover bid…”

The principles that emerge from Olympia & York Enterprises Ltd. v. Hiram Walker Resouces Ltd. are:

• When directors act in the best interests of the company and in good faith, it matters not that they also benefit from their action (in this case by becoming more entrenched in the company). In other words self-entrenchment will not necessarily be inferred where retaining control is secondary to the more important purpose of acting in good faith and in the company best interests.
• It is the duty of the directors in a take-over battle to take all reasonable steps to maximize shareholders value. In maximizing shareholder value directors may rely on professional advice as to the adequacy of a bid, and that such reliance will be evidence of acting in good faith and on reasonable grounds.

In considering the proper actions to be taken by directors in takeover bid scenarios, it is of some importance to come to grips with the principle that emerges from the U.S. case of Revlon Inc. v. MacAndrews & Forbes  Holdings Inc. 506 A.2d 173 (Del. 1986) which states that once defensive measures taken by the directors are moot , the role of directors changes from defenders of the corporation to auctioneers trying to get the best sale price for the company to benefit the shareholders. The exact words of Justice Moore of the Supreme Court of Delaware were:

“However, when Pantry Pride increased its offer to $50 per share, and then to $53, it became apparent to all that the break-up of the company was inevitable. The Revlon board’s authorization permitting management to negotiate a merger or buyout with a third party was a recognition that the company was for sale. The duty of the board had thus changed from the preservation of Revlon as a corporate entity to the maximization of the company’s value at a sale for the stockholders’ benefit. This significantly altered the board’s responsibilities under the Unocal standards. It no longer faced threats to corporate policy and effectiveness, or to the stockholders’ interests, from a grossly inadequate bid. The whole question of defensive measures became moot. The directors’ role changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.”

The Ontario Court of Appeal soundly rejected this so-called “Revlon Duty” for Ontario (at least) in Maple Leaf Foods Inc. v. Schneider Corp., (1998) 42 O.R. (3d) 177 (Ont. C.A.). Weiler J.A. for the Court of Appeal held:

“The decision in [Revlon] stands for the proposition that if a company is up for sale, the directors have an obligation to conduct an auction of the company’s shares. Revlon is not the law in Ontario. In Ontario, an auction need not be held every time there is a change in control of a company.

An auction is merely one way to prevent the conflicts of interest that may arise when there is a change of control by requiring that directors act in a neutral manner toward a number of bidders…The more recent Paramount decision in the United States …has recast the obligation of directors when there is a bid for change of control as an obligation to seek the best value reasonably available to shareholders in the circumstances. This is a more flexible standard, which recognizes that the particular circumstances are important in determining the best transaction available, and that a board is not limited to considering only the amount of cash or consideration involved as would be the case with an auction…There is no single blueprint that directors

must follow…

When it becomes clear that a company is for sale and there are several bidders, an auction is an appropriate mechanism to ensure that the board of a target company acts in a neutral manner to achieve the best value reasonably available to shareholders in the circumstances. When the board has received a single offer and has no reliable grounds upon which to judge its adequacy, a canvass of

the market to determine if higher bids may be elicited is appropriate, and may be necessary….”

 

So where does our law stand on the duty of the corporation to the shareholders?

Please note carefully the discussion beginning in the bottom paragraph of page 1209 and continuing on page 1210 of the Casebook. Not only does it constitute an important summary of the prevailing situation but also offers a very useful formulation to try and reconcile the divergent strands: “One way to make sense of this is that the Supreme Court of Canada’s interpretation [in BCE v. 1976 Debentureholders discussed earlier] of the duty of loyalty is such that directors may consider the interests of creditors and other stakeholders, but not that they must do so. Moreover, the rejection of Revlon can also be understood as the rejection of an idea that directors are confined to a short time frame when deciding what is in the best interests of the corporation.”

 

Finally please read the cases of:

1. 347883 Alberta Ltd. v. Producers Pipelines Inc. (1991) 3 B.L.R. (2d) 237 (C.A.) at pages 1212-1222 of the Casebook;

2. Brant Investments Ltd. v. Keeprite Inc. (1991) 3 O.R. (3d) 289 (C.A.) at pages 1224-1230 of the Casebook; and

3. CW Shareholdings Inc. v.WIC Western International Communications Ltd. (1998), 39 O.R. (3d) 755 (Ont. SC) which can be found here: http://www.canlii.org/en/on/onsc/doc/1998/1998canlii14838/1998canlii14838.html

 

These cases involve illustrations of courts wrestling with how to give relevant context to the duty of loyalty. That is that Directors must act honestly, in good faith, and with a view to the best interests of the corporation and furthermore exercise the care, diligence and skill that a reasonable person would exercise in like circumstances. Such specific responsibilities of the directors become considerably more challenging to navigate in change of control situations where the corporation can be said to be “in play”.

 

347883 Alberta Ltd. v. Producers Pipelines Inc. dealt with a “shareholder’s rights agreement”, also known as a poison pill defence. A “Poison pill” is a defensive strategy against corporate takeovers. It can broadly be defined as an extra-ordinary manoeuvre by the directors and/or shareholders of the company to be acquired designed to make that target company less attractive to the hopeful acquirer, often by adding burdensome costs if the takeover succeeds. In 347883 Alberta Ltd. v. Producers Pipelines Inc. the directors of Producers Pipelines Inc., a public company that the parent company of 347883 Alberta Ltd. wished to acquire, enacted a “shareholders rights agreement”. That shareholders rights agreement would give each of the fewer than 200 shareholders of Producers Pipelines Inc. 10 shares for the price of $75. The offer was crafted in such a way that 347883 Alberta Ltd. (as a subsidiary of the putative acquirer) would not receive these rights and the acquirer’s own shares would be greatly diluted. In dealing with the appropriate conduct of directors Sherstobitoff J.A. reviewed the state of the law extensively and concluded:

“In summary, when a corporation is faced with susceptibility to a take-over bid or an actual take-over bid, the directors must exercise their powers in accordance with their overriding duty to act bona fide and in the best interests of the corporation even though they may find themselves, through no fault of their own, in a conflict of interest situation. If, after investigation, they determine that action is necessary to advance the best interests of the company, they may act, but the onus will be on them to show that their acts were reasonable in relation to the threat posed and were directed to the benefit of the corporation and its shareholders as a whole, and not for an improper purpose such as entrenchment of the directors.

Since the shareholders have the right to decide to whom and at what price they will sell their shares, defensive action must interfere as little as possible with that right. Accordingly, any defensive action should be put to the shareholders for prior approval where possible, or for subsequent ratification if not possible. There may be circumstances where neither is possible, but that was not so in this case. Defensive tactics that result in shareholders being deprived of the ability to respond to a takeover bid or to a competing bid are unacceptable.”

The end result was that the Ontario Court of Appeal determined that the shareholder’s rights agreement in this particular case was to be set aside.

 

The facts in Brant Investments Ltd. v. KeepRite Inc. involved a complex corporate transaction where the board of the parent company Inter-City Gas purchased 64% of the shares in KeepRite Inc. a company that sold air conditioning equipment. Then Inter-City Gas transferred the shares it had acquired in Keeprite Inc. to Inter-City Manufacturing, a subsidiary of Inter-City Gas, which made heating equipment. Thereafter, following the recommendation of an independent committee of the board of KeepRite Inc., KeepRite Inc. purchased $20 million of assets from two companies that were subsidiaries of Inter-City Manufacturing. An issue of rights to existing shareholders financed this purchase. Of note was that this rights offering required an amendment to the articles of KeepRite Inc. that was passed by a special resolution of the shareholders. The minority shareholders of Keeprite Inc. objected to the transaction, brought an oppression action, and applied for an order to fix the fair value of their shares to be put to the corporation.

In simplified form this was essentially a transaction where the board of a parent proposed to purchase the assets of a subsidiary, and the shareholders of the parent company objected.

McKinlay J.A. agreed with the lower court that section 234 (now section 241) of the CBCA was not offended by the actions of KeepRite Inc. Accordingly the action of the minority shareholders of KeepRite Inc. against that company failed. The court found:

“There can be no doubt that on application under s. 234 the trial judge is required to consider the nature of the impugned acts and the method in which they were carried out. That does not mean that the trial judge should substitute his own business judgment for that of managers, directors, or a committee such as the one involved in assessing this transaction. Indeed, it would generally be impossible for him to do so, regardless of the amount of evidence before him. He is dealing with the matter at a different time and place; it is unlikely that he will have the background knowledge and expertise of the individuals involved; he could have little or no knowledge of the background and skills of the persons who would be carrying out any proposed plan; and it is unlikely that he would have any knowledge of the specialized market in which the corporation operated. In short, he does not know enough to make the business decision required. That does not mean that he is not well equipped to make an objective assessment of the very factors which s. 234 requires him to assess. Those factors have been discussed in some detail earlier in these reasons.

It is important to note that the learned trial judge did not say that business decisions honestly made should not be subjected to examination. What he said was that they should not be subjected to microscopic examination…Having carefully reviewed the major aspects of the appellants’ criticisms of the transaction, he came to the conclusion that in no way, either substantively or procedurally, offended the provisions of s. 234. Having carefully reviewed all of the exhibits and transcribed evidence to which we were referred, I have no hesitation in agreeing with the correctness of his assessment…” 

One of the key points about Brant Investments Ltd. v. KeepRite Inc. is that the case illustrates well the sense of “protection” (real or imagined) that “independent committees” can provide in a corporate setting, particularly in a takeover scenario. The key factor would appear to be the appearance of objectivity and focus which an independent committee is capable of bring to business judgments regarding what would be in the best interests of the corporation. Accordingly it has become fairly standard practice for independent committees to be formed and convened at an early stage of takeover issues (and others as well) that might prove contentious. Given that most, if not almost all takeovers meet these criteria, “independent committees” are unlikely to be going out of style any time soon.

 

CW Shareholdings Inc. v. WIC Western International Communications Ltd. involved an offer made by CanWest Global Communications Corp. (“CanWest”) to acquire all of the Class A voting shares of WIC Western International Communications Ltd. (“WIC”) and all of the publicly traded Class B non-voting shares of WIC at a price of $39 per share. At the relevant time the Class A voting shares of WIC were held approximately 49.96% by Shaw Communications Inc. and 50% by Cathton Holdings.

In response to the offer from CanWest, the board of WIC created a “special committee”, which included the CEO, to consider the offer. The board of WIC subsequently recommended through a “Directors’ Circular” that the shareholders of WIC not accept the offer from CanWest. The board of WIC also passed without the approval of its shareholders a “shareholders rights plan”.

In its various decisions dealing with the WIC matter the Ontario Securities Commission identified certain challenges with the non-independence of WIC’s “special committee” relating to the participation of John Lacey the CEO of WIC at the relevant time and of another director, Robert Manning, who represented Cathton Holdings, the largest holder of the Class A shares of WIC, who was at first allowed to attend meetings of the special committee but without voting rights. The OSC considered the special committee not to truly be an independent committee:

“From the evidence of Messrs. Lacey, Eyton and Spafford, it appears clear to us that the Special Committee was set up for purposes of convenience only, and not as an independent committee. In our view, in a take-over bid context a committee which includes as an active participant the president and chief executive officer of the corporation and, as an observer and resource, a representative of a shareholder which has 50% of the votes, is not an independent committee. The fact that Mr. Lacey has a “golden parachute” agreement, does not in our view change this position.

In these circumstances, it is our view that we must place less reliance on the review by the Special Committee of the Bid, and possible alternative methods of achieving a more beneficial result to shareholders, than we would if the Special Committee had been truly an independent committee.”

As well in its reasons to cease trade the shareholder rights plan, the Ontario Securities Commission stated in relation to the testimony of Rhys Eyton, the Chair of the “special committee” that:

“We should also note that Mr. Eyton’s apparent view that the board of a target company, as well as its shareholders, are entitled to take part in the decision as to whether to accept the bid is not correct, based on previous decisions of the Commission, if by his statement to that effect Mr. Eyton meant any more than that the board of the target company is entitled to advise the shareholders and attempt to provide them with alternatives.”

The rights plan was cease-traded by securities regulators, and thereafter negotiations began between WIC and Shaw Communications Inc., who made a cash and share offer valued at $43.50 per share for all of the outstanding Class B nonvoting shares. Related to this offer WIC and Shaw Communications Inc. entered into a “pre-acquisition agreement” which granted Shaw Communications:

• An irrevocable option to purchase WIC’s radio assets (which were said to have been underperforming) at a fixed price of $160 million. Note that these radio assets only represented 0.6% of WIC’s total income in 1997.
• A break fee of $30 million if certain events transpired within a limited time; and
• A covenant which would prevent WIC from soliciting or encouraging any other “acquisition proposals”, but which did allow WIC to negotiate, approve and recommend unsolicited bona fide acquisition proposals.

Subsequently CanWest increased its bid to $43.50 on condition that the Court setting aside the pre-acquisition agreement. Over and above the various proceedings Canwest had started before securities commissions, it also applied to the Ontario courts to set aside the pre-acquisition agreement and for relief from “oppression” in accordance section 241 of the CBCA. The issue before the courts was whether WIC’s Board had breached its fiduciary duties by approving the pre-acquisition agreement with Shaw. In the end while the Ontario Court (General Division) can be said to have been somewhat critical of certain aspects of the pre-acquisition agreement and might be seen as questioning to some degree the independence of the special committee, it did not set aside the pre-acquisition agreement and concluded that the WIC Board had acted in accordance with its fiduciary duties.

Mr. Justice Blair contextualized the concept of a corporation being “in play” and described the duties of directors in such circumstances:

“The law as it relates to the general duties of the directors of Canadian corporations is not controversial. The directors must exercise the common law fiduciary and statutory obligations (a) to act honestly and in good faith with a view to the best interests of the corporation, and (b) in doing so, to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances: see the Canada Business Corporations Act, R.S.C. 1985, c. C-37, s.122. In the context of a hostile takeover bid situations where the corporation is “in play” (i.e., where it is apparent there will be a sale of equity and/or voting control) the duty is to act in the best interests of the shareholders as a whole and to take active and reasonable steps to maximize shareholder value by conducting an auction…

In assessing whether or not directors have met their fiduciary and statutory obligations, as outlined earlier in these Reasons, Canadian courts have generally approached the subject on the basis of what has become known as the “business judgment rule”. This rule is an extension of the fundamental principle that the business and affairs of a corporation are managed by or under the direction of its board of directors. It operates to shield from court intervention business decisions which have been made honestly, prudently, in good faith and on reasonable grounds. In such cases, the board’s decisions will not be subject to microscopic examination and the Court will be reluctant to interfere and to usurp the board of director’s function in managing the corporation. …

The directors’ actions are not to be judged against the perfect vision of hindsight, and should be measured against the facts as they existed at the time the impugned decision was made. In addition, the court should be reluctant to substitute its own opinion for that of the directors where the business decision was made in reasonable and informed reliance on the advice of financial and legal advisors appropriately retained and consulted in the circumstances. See Rogers Communications Inc. v. MacLean Hunter Ltd., supra, at p. 245; Armstrong World Industries Inc. v. Arcand (1997), 36 B.L.R. (2d) 171 (Ont. Gen. Div. [Commercial List]); Olympia & York Enterprises Ltd. v. Hiram Walker Resources Ltd., supra at pp. 270-273.”

 

UNIT WRAP UP:

Now having achieved some appreciation of how the “mind” of the corporation is operated and managed by directors and management, we come to the rest of the world. What rights and remedies do shareholders and others have?

 

HYPOTHETICAL 

You are a young corporate lawyer at the well-known British Columbia law firm Wie, Haight, Raye & Darr. The firm’s client Gates Williams makes an appointment to meet with you. He arrives at your office with J.O.B. Steves whom he introduces as his partner in a new venture. Mr. Williams asks you to incorporate a new company under the BCBCA.

They tell you that the company is being formed to exploit a potentially highly profitable new business opportunity that has arisen as the result a decision by the Canadian International Development Agency (“CIDA”) an agency of Canada’s Department of External Affairs to invite tenders from private sector companies for contracts to provide services that CIDA wishes to have provided in Guatemala. Mr. Williams mentions that Mr. Steves’ son-in-law is a very senior official at CIDA.

Mr. Williams that the shareholdings in the new company will be as follows:

1. Gates Williams 1000 Class A Voting common shares to be paid for in cash
2. O.B. Steves 1000 Class A Voting common shares to be paid for in cash
3. C. Ahn 100 Class A Voting common shares (who is not at the meeting) to be paid for in cash

Mr. Williams asks you whether Wie, Haight, Raye & Darr would take 200 Class A Voting common shares in lieu of fees.

Since Mr. Williams and Mr. Steves are in rather a rush they tell you that the company should have standard form articles along the lines of the model BC Articles, that Mr. Williams will be the sole officer and director of the company and that Mr. Steves will call later with additional instructions and information. Later the same day Mr. Williams (not Mr. Steves) calls and asks you prepare an employment agreement between Mr. Williams as President & CEO, and the new company. The employment agreement will have a term of two years and provide a salary of $500,000 per year.

Please identify briefly any legal or, in the light of the following provisions of the Law Society of BC Code of Professional Conduct, any ethical issues: s. 1.1-1 (definition of “conflict of interest”); s. 3.2-7; s. 3.2-8; s. 3.4-1; s. 3.4-28.