Court ruling on director’s compensation a warning for boards

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Amid a climate of continuing concern over executive pay, boards of directors looking to hand themselves big bonus packages or stock options will think twice after a recent ruling from the Ontario Court of Appeal, corporate governance experts say.

The ruling involves a company called Unique Broadband Systems Inc. (UBS), which went into bankruptcy protection in July, 2011, and owned a controlling interest in an upstart cable and Internet company called Look Communications Inc.

A court fight erupted after shareholders objected to a move by directors of both companies to authorize about $20-million in payments to themselves and some consultants. The payments came after Look sold its wireless spectrum to a partnership of Bell and Rogers in 2009 for $80-million.

In the July 10 decision, the Court of Appeal ruled that Gerald McGoey, who served as both a director and chief executive officer of both UBS and Look, was not entitled to millions in bonuses and a "golden parachute" in severance pay because he had breached his fiduciary duty to act in the best interests of UBS.

According to the appeal judgment, Mr. McGoey and the UBS board's compensation committee, which had no independent members, met and voted to give themselves larger bonuses after the spectrum sale, despite what was deemed a disappointing price. The decision was made without any comparisons to what other directors had been paid in similar situations, the ruling said.

While legal experts say the ruling in the case does not create any new law, it is one of only a handful of Court of Appeal decisions on these issues and it clarifies the duties of directors faced with decisions involving their own pay.

Those most concerned with the decision's implications will be directors involved in what law professor Richard Leblanc calls "grey" boards with less rigorous corporate governance.

"This I think will move the bar," said Prof. Leblanc, who teaches at Osgoode Hall law school in Toronto and advises corporate boards. "... The 'grey' directors will worry."

He said the decision reinforces the need for corporate boards to appoint independent directors to compensation committees to decide on pay, as well as hire compensation experts to produce reports showing what other comparable directors make, in order to ensure decisions are beyond reproach.

Carol Hansell, a Toronto lawyer who specializes in corporate governance, highlighted the appeal decision's striking down of an earlier ruling that said Mr. McGoey was entitled to at least his severance pay, despite his breach, because his contract entitled him to it.

She said directors and executives often try to line contracts with safeguards like this, but this decision highlights that such efforts are doomed to fail: "You can't contract out of your fiduciary duty ... It's helpful to have that showcased by the Court of Appeal."

Clifford Cole of Gowling Lafleur Henderson LLP, lead lawyer for UBS in the case, said the ruling shows that boards cannot always shelter behind the so-called "business judgment rule" that sees courts give deference to business decisions.

"This decision, both at the trial level and at the Court of Appeal level, is a true victory for stakeholders, for shareholders," Mr. Cole said. "It sets clear parameters on what [boards] can do and how they can do it, and what they need to have to justify what they've done."

Toronto lawyer Joe Groia, who acts for Mr. McGoey, said he did not think the decision would have any effect on corporate governance, as it does not create any new duties or tests for directors.

He said the fight at the heart of the dispute is actually due in court next year, in a parallel case that pits Look Communications Inc. against Mr. McGoey and other former directors. He said the recent appeal decision would have "very little impact" on that trial.

"Mr. McGoey is obviously disappointed," Mr. Groia said. "He still believes that based on what he was told and the advice he got at the time, he thought he was acting appropriately. The court has said he was not, and he respects that statement."