By Howard Levitt

Things can get messy if fiduciary duty to the company is breached

Executives, directors, and officers must think long and hard, very hard, before becoming involved in establishing their own compensation. In this era of corporate governance and the accompanying rigorous scrutiny of executive compensation, keep in mind the following headlines: “Lloyds faces shareholder revolt as CEO’s pay is 95 times that of average worker”; “Americans’ wages are lagging inflation — except for CEOs, whose pay jumped 18%” and “Metro Vancouver directors vote themselves a golden handshake.”

But it is not just bad branding and embarrassment to themselves and their families. There is also the prospect of long, drawn-out lawsuits, dismissals for cause and orders to repay all sums deemed “inappropriate”: stock options, dividends, salaries, bonuses — even their hard-negotiated wrongful dismissal payments, not to mention additional damages for breach of fiduciary duties. And all that before, or perhaps both before and after, an eventual public decision that they placed their own interests over those of their employers. And that may be a mere prelude to trouble on the home front, where the embarrassment can lead to a rift with children and loved ones and divorce is a real possibility.

Few think of such collateral consequences, but they should.

Even the most experienced executives and board members should pause and proceed with care and caution — lest they, too, end up in such a cautionary tale.

Since directors at many public companies are hand-picked by the CEO or, at the least, they develop close relationships, such conflicts can easily be alleged by disgruntled shareholders or dissident directors.

It is a delicate path to navigate: the executive or board member may, and should, protect and advocate for their own interests, but must check every step of the way that the company’s interests are also being adequately represented.

After all, that superb severance package you negotiated for yourself will appear less salutary after spending three years litigating for it — or if shareholders or a new owner emerge victorious and demand reimbursement.

Negotiation of compensation at this level is almost inherently a conflict of interest. Directors and officers want to be sure that the compensation packages they negotiate for themselves, and the compensation packages they approve for their peers, are in line with their fiduciary obligations. Not only must the deal be fair, but the process of achieving it must be transparent, particularly if the compensation is complex and has the potential for vast rewards.

Ronald Goegan was with Royal Group for 14 years and had become its CFO, senior vice-president, and a member of its board of directors.

Despite his credentials, Goegan managed to violate his fiduciary duties twice over, and paid dearly for it.

In 1997, a group of the company’s executives purchased land that Royal Group had chosen not to buy. Unlike the other executives, Goegan did not profit from it but was penalized by the court for facilitating it, considering that a breach of his fiduciary duty. Goegan found himself investigated by the OSC and by a committee of Royal Group’s board and was then fired for cause. But that was just the start for this unfortunate executive.

He sued for wrongful dismissal and, as can occur with good defence counsel, Royal Group’s exploration ascertained new “cause.” Years earlier, Royal Group arranged a joint venture with a company, Premdor, that involved the sale of a Royal Group subsidiary to it. Part of the purchase price was a share warrant from Premdor. This share warrant allowed Royal Group to purchase 200,000 more shares of Premdor at the price of $13.25, higher than the current share price. As part of the sale, three per cent of the warrant was allocated amongst various executives, including Goegan, in lieu of a bonus.

When the share price exceeded $13.25, Royal Group called in the warrant and Goegan sold his portion of the shares for a $200,000 profit. Goegan and the others had been entitled to a bonus which this replaced, but Goegen ended up with a higher bonus than he normally received.

Royal Group’s bonus plan required that Royal Group obtain shareholder approval before any changes to the plan could be made, approval which was never even sought. As a result, Justice Frederick Myers found that Goegan and other Royal Group executives had effectively appropriated a corporate asset once it became valuable in breach of their fiduciary duty. On appeal, the Ontario Court of Appeal noted that the executives had tried to conceal what had occurred.

Goegan ended up paying $790,651.30 toward Royal Group’s legal fees. Although Royal Group did not counterclaim and sue Goegan for breach of fiduciary duty, it could have.

The case highlights the necessity of being transparent with all stakeholders when negotiating or revising executive compensation.

When senior executives negotiate their own compensation, it is perilous to entirely rely on the approval of the Compensation Committee.

Gary Conn was a shareholder, officer, and director of Goldstone Resources Ltd. He had signed a management agreement (the “MCA”) with Goldstone’s predecessor, Ontex, in 2008 that came with a five-year term and gave Conn the right to renew it for another five years, with the only exception being just cause. When he was terminated two years later, Conn tried to rely on the contract. But Justice Duncan Grace set aside the compensation and termination because of both the decision-making process that led to it and the unfairness of these terms themselves.

In Conn’s case, there were a couple of different problems with the compensation committee approval.

First, he was friends with the head of the committee — which, in light of the agreement being heavily in Conn’s favour, raised serious concerns about how neutral and effective the committee had been. It also did not use the appropriate comparators in coming up with his compensation.

As the court put it: “The decision-making process leading up to the 2008 MCA was woefully deficient. The evidence supports only one conclusion: the agreement was presented in the form Conn desired and was rubber stamped by a Compensation Committee and board of directors that was friendly to him, rather than mindful of the responsibilities the law imposes.”

Justice Grace held that a contract “flowing from a breach of the required standard may be set aside by the court in whole or in part.”

Conn likely was elated by the contract he signed, but all he was left with was a mountain of woe.

It is critical to be able to prove that the contract was more than rubber-stamped and that it was reasonable in the marketplace compared to similar compensation for analogous positions in the marketplace.

If not, you risk what the Court held here: “The annual increase and termination provisions are bewildering in their scope and indefensible on the evidence presented. The terms of the 2008 MCA resulted from an abdication of responsibilities rather than business judgment. Conn was the person who orchestrated a selfish and over-reaching deal.”

It added that Conn’s actions “were driven by self-interest, unsupported by any reasonable or objective criteria, and contrary to the interest of” the company he was obliged to protect. Conn breached the fiduciary duties he owed.

As result of his misconduct, Justice Grace held Conn had properly been terminated for cause, set aside the compensation and termination provisions, and dismissed his claim.