Oppression

27 Million Severance

UPM-Kymmene Corp v UPM-Kymmene Miramichi Inc, a decision of the Ontario Superior Court dealt with a shareholder oppression remedy to set aside an employment contract which allowed for a $27 million severance payment to a director.

Steve Berg was a director and Chairman of the Board of Directors of Repap, a Canadian public company in the forest products business from January to August 1999. He was also the largest single individual shareholder owning 4.3% of the equity.

Berg’s proposed employment agreement was presented at two Board meetings in February and March 1999. At the February meeting, it was hotly debated and not approved. The board retained independent counsel to examine it. The Compensation Committee was asked to consider and report back to the board as to its prudence. After the meeting, two directors resigned, one of whom was Chair of the Compensation Committee.

In March before a differently constituted Board and upon the approval of a newly constituted Compensation Committee, the agreement was approved. The agreement was generous and included a five year employment term with renewals, a signing bonus of 25 million shares, a stock option grant of 75 million shares, a market capitalization bonus, immediate pension credit of 8 years and liberal change of control and termination provisions. Berg then became Chairman and Senior Executive Officer of Repap.

The Board relied in part upon an opinion of an executive compensation consultant. She believed that she was advising on a non-contentious matter. She was not aware Berg was unknown to the Board members nor the prior February resistance to the contract. The Board was equally unaware of this history.

Opposition to the contract was swift. A proxy fight was commenced to replace the Board. The outside directors soon resigned and a new Board was appointed. Berg was not nominated to stand for election. Berg terminated his employment under the agreement and sued for $27 million in New York state, which action was stayed after which the Ontario oppression remedy proceeded to trial.

At trial before Justice Lax, she concluded: (1) Berg breached his fiduciary duty to the manner of presenting and negotiating his own contract for approval; (2) The Compensation Committee and the Board failed in their obligations to establish a fair process that led to a contract which was unfair; (3) the agreement unfairly disregarded the interests of the shareholders.

The first obligation of the party in conflict is to make disclosure, the test of which is to make clear “the real state of things”. This was referenced in the decision of the trial judge:

In Gray v. New Augarita Porcupine Mines Ltd., a decision of the Judicial Committee of the Privy Council, on appeal from the Ontario Court of Appeal, the court had to consider the level of disclosure that is required to meet the statutory requirement. Lord Radcliffe stated:

There is no precise formula that will determine the extent of detail that is called for when a director declares his interest or the nature of his interest. Rightly understood, the two things mean the same. The amount of detail required must depend in each case upon the nature of the contract or arrangement proposed and the context in which it arises. It can rarely be enough for a director to say, “I must remind you that I am interested” and to leave it at that… His declaration must make his colleagues “fully informed of the real state of things” (see, Imperial Mercantile Credit Ass’n v. Coleman (1873), L.R. 6 H.L. 189 at 201, per Lord Chelmsford). If it is material to their judgment that they should know not merely that he has an interest, but what it is and how far it goes, then he must see to it that they are informed.

The Court found that Berg failed to inform the Board of “the real state of things” that was material to the judgment of the Board, including comments of past Board members and all other relevant details. Lax J. stated:

Measured against this standard, Mr. Berg’s conduct falls well short of what was required of him. The Repap directors were not fully informed of ‘the real state of things’. It was material to their judgment to know about the comments of management and prior Board members on his compensation package. It was material to their judgment to know that Mercer had not done any research, benchmarking or analysis of comparable companies as requested by the Board at the February 22, 1999, meeting. It was material to their judgment to know that the Agreement tabled before it on March 23, 1999, was different in several important respects from the version they received with the March 18, 1999, memorandum. It is no answer to the duty to disclose to say the directors could have discovered this for themselves. The duty to disclose is an absolute one, because, without full disclosure, any investigation into whether the beneficiary would have acted in the same manner is impossible.

Disclosure of a director’s interest is the first step. The director still must act honestly and in good faith. Berg instructed legal counsel himself, which the Court found was legal counsel to the corporation, contrary to his fiduciary duty. Berg is so doing acted in his own best interest and disregarded the interests of the company. The court stated the test as follows:

Disclosure of a director’s interest is but the first step. Disclosure does not relieve the director of his duty to act honestly and in good faith with a view to the best interests of the corporation. The director must always place the interests of the corporation ahead of his own.[3] Pente Investment Management Ltd. v. Schneider Corp.[4] and CW Shareholdings Inc. v. WIC Western International Communications Ltd.[5] are take-over bid cases. They are helpful decisions because they raise conflict of interest issues that are not unlike those that can arise in a director-corporation transaction. The classic way that Boards protect themselves when conflicts arise is to retain independent legal and financial advisors and to establish independent or special directors’ committees

The Compensation Committee exercised no meaningful oversight. It took no legal advice or expert advice. It took no steps to learn of the prior discussions from previous Board or Committee members.

The contract made it all most impossible to terminate Berg for cause, which given that Berg was a stranger to the Board and the termination provision called for $27 million, was viewed as a violation of the Board’s obligation to its shareholders.

Section 120 of the CBCA presumes the invalidity of a contract between a director and the corporation, failing approval of the Board, disclosure requirements are met and the contract is fair and reasonable. The Court, however, elected to apply the oppression remedy and set aside the employment agreement. It was noted that there was alternative relief available under Section 120(7) of the Act. The Court of Appeal agreed.

The Ontario Court of Appeal came to a similar conclusion in the 2014 decision of Re: Unique Broadband Systems. This Court agreed with the trial judge, Mesbur J. who struck down an award of Stock Appreciation Cancellation Awards and a bonus pool as void of any genuine business judgment which would render value to the public shareholders. As to the SAR Cancellation Award, the Court of Appeal stated:

With respect to the SAR Cancellation Awards, the trial judge concluded that there was no evidence as to how the UBS Board arrived at the non-market price of $0.40 per unit and how it determined that it was in the best interests of the corporation. The UBS Board provided no credible analysis to justify why they considered that these payments, which represented a significant percentage of UBS market capitalization, were fair and reasonable in the circumstances.

The bonus pool award of 1.2 million was set aside on similar logic, namely, that the Board had no rational basis for making this determination:

The trial judge rejected the position of Mr. McGoey that there was a reasonable rationale for the establishment of the Bonus Pool and his allocation of $1.2 million. This finding was well supported by the evidence at trial, including the following.

[59]      The UBS Board did not seek or receive any expert advice on an appropriate bonus structure. Nor did they have any comparable or other data regarding executive compensation in the marketplace.

[60]      There was no documentation that stipulated the performance factors or criteria by which Mr. McGoey’s performance would be evaluated. The trial judge rejected Mr. McGoey’s evidence that the services he provided for Look qualified as the criteria under which he could be awarded a bonus by UBS.  She concluded that, when the UBS bonus was awarded, there were, in fact, no criteria.

[61]      Similarly, there was no documentation that showed how the Bonus Pool was quantified. The best evidence we have is that Mr. McGoey went to a UBS Board meeting seeking to establish a $7 million bonus pool but the UBS Board found that amount “too high” and established a $3.4 million bonus pool instead.

The defence asserted by McGoey of the business judgment rule was found to be inappropriate as this was founded on conduct undertaken honestly and on good faith, which conduct was absent in this instance. This rule, the Court of Appeal stated, was a presumption which may be rebutted:

The trial judge properly concluded that the business judgment rule was of no assistance to Mr. McGoey because he did not satisfy the rule’s preconditions of honesty, prudence, good faith, and a reasonable belief that his actions were in the best interests of the company: Corporacion Americana de Equipamientos Urbanos S.L. v. Olifas Marketing Group Inc., 2003 CanLII 22758 (ON SC), (2003), 66 O.R. (3d) 352, at paras. 13 and 14 (S.C.).

[72]      It must be remembered that the business judgment rule is really just a rebuttable presumption that directors or officers act on an informed basis, in good faith, and in the best interests of the corporation. Courts will defer to business decisions honestly made, but they will not sit idly by when it is clear that a board is engaged in conduct that has no legitimate business purpose and that is in breach of its fiduciary duties. In the present case, there was ample evidence upon which the trial judge could base her conclusion that the presumption had been rebutted.

In this case, McGoey was successful at trial in recovering an enhanced severance payment under his employment agreement. This decision was based on an interpretation of the just cause provision, one which the Court of Appeal reversed, given the finding made of the breach of fiduciary duty, which this court saw as just cause to avoid the termination payment.

As to the oppression argument, the Court of Appeal itself did not consider this plea, as the termination payment was nullified by the finding of cause. It did state, however, that the oppression remedy ought to have been adjudicated by the trial judge, given that she had found no cause for termination, the oppression argument was then still live:

Given my finding regarding the proper interpretation of the Jolian Management Services Agreement, it is not necessary to consider UBS’s argument that the trial judge erred in failing to consider the oppression remedy argument advanced by UBS. I only note that the trial judge, having concluded that Mr. McGoey was entitled to receive Enhanced Severance, had an obligation to consider the oppression argument. Contrary to her conclusion, the setting aside of the SAR Cancellation Award and the Bonus Award did not cure Mr. McGoey’s wrongful conduct. It was still necessary to determine whether the entitlement to Enhanced Severance was oppressive.

The Court of Appeal noted that the oppression remedy was one designed to remedy conduct of corporate wrongdoing at the instance of shareholders or other eligible parties:

[107]   The oppression remedy is a flexible, equitable remedy that affords the court broad powers to rectify corporate malfeasance. It is an important remedy for shareholders and other corporate stakeholders. In the circumstances of this case, it may well have provided a remedy to protect the interests of the shareholders.

[108]   It was an error in law not to consider the oppression remedy in these circumstances.

In a similar case, Rooney v Cree Lake Resources 1998 O.J. 3077, Dilks J. of the Ontario Court, General Division ¹ concluded that the severance agreement was unenforceable as it required the employer to pay unearned compensation in a lump sum equal to 70% of the company’s assets where there was no reasonable expectation of sufficient funds to support this payment.