Introduction

Executives, directors, and officers work hard, and that should be recognized.

But before you or any member of a board take any steps to set up compensation, take a second and imagine the possible headlines. Or maybe don't imagine, just Google—it's easy to find outrage about the gall of executives who vote to give themselves a particularly good deal:

“Hydro One Board Members Approved $25k Raises for Themselves”¹

“Metro Vancouver Directors Vote Themselves a Golden Handshake”²

“Lloyds Faces Shareholder Revolt as Ceo's Pay Is 95 Times That of Average Worker”³

“Fiduciary Officers Owe Duty to the Company, Not Their Wallets”⁴

And this doesn't cover all the potential legal consequences: long, drawn-out lawsuits; termination; orders for repayment of any and all sums deemed “inappropriate,” including bonuses, stock options, dividends, salaries, and termination packages; monetary penalties for breaches of fiduciary duties; court orders tying up funds; and perhaps an eventual decision that a court found you to have violated your duties and placed your own interests over those of the company—something no individual would want as their reputation.

Negotiating deals might be an everyday occurrence, but when executive compensation is on the table, even the most experienced executives and board members should pause and only proceed with care and caution—lest they, too, end up as a cautionary tale in a chapter such as this.

It is a delicate path to tread: 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 excellent severance package you negotiated for yourself as CEO will look a lot less excellent if you have to spend three years litigating for it in court—or worse yet, if shareholders or a new owner emerges victorious and require you to repay it.

This chapter is a brief look at the interaction between employment law, executives, and the fraught realm of negotiating executive compensation. Along the way we'll look at some of the executives and directors who ran afoul of these principles—and who now act as unfortunate reminders of what not to do.

The Overarching Principle of the Fiduciary Duty

Officers and directors owe a fiduciary duty to their company.⁵ The fiduciary duty is one of utmost loyalty, good faith, and the avoidance of conflicts of interest. Because directors, officers, and senior management have a high degree of control over corporate operations, the courts recognize that those same individuals should be required to maintain exemplary behavior. At its most fundamental, it is meant to protect companies from being taken advantage of by those to whom it is vulnerable.

Some aspects of the duty are easily determined by common sense: an executive cannot, for example:

• Steal a corporate opportunity,
• Use insider knowledge to make a profit, or
• Compete with the company while being an executive of that company.

It is significantly more complicated where it comes to compensation. In general, transparency is key:

• It is not a violation of the fiduciary duty for a board member, executive, or director to negotiate their own compensation, despite the very act being against the interests of the company.
• It is a violation if the executive fails to be scrupulously honest during negotiations.
• It is a violation if the executive or director winds up with a better deal than they would fairly be entitled to if the negotiation had been an arm's-length one.

Negotiation of compensation at this level is 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. This means that not only must the deal itself be fair, but the process of achieving that deal should also be as transparent and neutral as possible.

This is particularly true with complex compensation schemes: stock options, restricted share units (RSUs), long- and short-term incentive plans, profit sharing, bonuses, spending allowances, base salary and benefits, and perhaps most critically, termination packages—all of it must be dealt with transparently and, as discussed ahead, must be reasonable under the circumstances.

In terms of cases regarding what the fiduciary duty looks like in practice, few cases are as instructive as Dunsmuir v Royal Group Inc.⁶ and the unfortunate case of Ronald Goegan.

At the time of his termination, Mr. Goegan had been with Royal Group for 14 years and had risen far up the corporate ladder: He was the chief financial officer, senior vice president, and a member of the board of directors. Unfortunately, despite his clear credentials, Mr. Goegan managed to violate his fiduciary duties twice over, and he paid dearly for it.

First, in 1997, Mr. Goegan involved himself in a problematic land deal in which he certainly took the short end of the stick. Although worth reading about, for the purposes of this chapter it is enough to say that the deal was structured around land that Royal Group itself decided it did not want to purchase. A group of Royal Group executives therefore purchased the land—and later ended up selling the lands to Royal Group for a profit.⁷ Mr. Goegan, unlike other executives, did not profit from the deal but got rightfully penalized from the court for the violation of his fiduciary duty in facilitating the deal.

This unwise deal saw Mr. Goegen drawn into an Ontario Securities Commission investigation and an investigation by a Special Committee of the Royal Group Board of Directors, and then terminated for cause.

But that was only the beginning of Mr. Goegan's troubles. After being terminated, Mr. Goegan chose to sue for wrongful termination (a decision that he likely regrets in hindsight).

In the midst of the lawsuit, Royal Group discovered that Mr. Goegan had been involved in the allocation of certain compensation to executives, including Mr. Goegan. Royal Group therefore argued it should not have to pay anything to Mr. Goegan on the basis of his violating his fiduciary duties.

And Royal Group won. What had happened was that years ago, Royal Group had arranged a joint venture with a company by the name of Premdor. The deal was structured as the sale of a Royal Group subsidiary to Premdor. Part of the agreed-to purchase price was a share warrant from Premdor.

The share warrant allowed Royal Group to purchase 200,000 more shares of Premdor at the price of $13.25, which was higher than the current share price. As part of the sale, 3 percent of the warrant was allocated among various executives, including Mr. Goegan, in lieu of a bonus.

When the share price exceeded $13.25, Royal Group called in the warrant. Mr. Goegan was able to sell his portion of the shares for a profit of almost $200,000. This might seem reasonable. Mr. Goegan and the other executives were, after all, regularly entitled to bonuses, and the Premdor warrant was meant to replace said bonus. Mr. Goegan testified at his trial that the warrant was held in trust for the senior executives.

The problem was that because of the Premdor warrant, Mr. Goegan ended up with a higher bonus than he normally received—and Royal Group's bonus plan required that Royal Group obtain shareholder approval before any changes to the plan could be made. Neither Royal Group nor Mr. Goegan had ever sought, or obtained, such approval.

As a result, Justice Frederick Myers found that Mr. Goegan and other Royal Group executives had, in a breach of their fiduciary duties, effectively appropriated a corporate asset once it had become valuable.

Mr. Goegan appealed, but also lost on appeal in September 2018.⁸ The Ontario Court of Appeal made particular note of the fact that executives had tried to conceal the change from shareholders:

7 When management's bonuses, which included the profits made by senior management on the exercise of the warrants, were disclosed as part of the respondent's regular reporting, there was a public outcry from shareholders. The appellant then allowed a different story to be told to the independent directors that covered up the reason for which senior management's bonuses were greater than what the approved bonus plan provided.

The final tally for Ronald Goegan? He lost his lawsuit and ended up paying $790,651.30 in Royal Group's legal fees. Thankfully for Mr. Goegan, Royal Group decided against suing him in return.

Mr. Goegan's case is an excellent illustration of the first important factor in balancing executive compensation and fiduciary duties:

The Approval of a Compensation Committee Isn't Necessarily Enough

So, your executive has proposed and negotiated a compensation scheme, and the company's compensation committee has reviewed and approved. That should be sufficient, right? Don't be so sure.

Gary Conn was a shareholder, officer, and director of Goldstone Resources Ltd.⁹ In 2008, he had signed a management agreement (the “MCA”) with Goldstone's predecessor, Ontex;¹⁰ the 2008 MCA:

• Had a term of five years,
• Gave Mr. Conn the right to renew it for five more years, and
• Ontex was only able to terminate it for cause.¹¹

When Mr. Conn was terminated in 2010, he attempted to rely on the 2008 MCA's compensation and termination provisions for claims worth several million dollars. However, Justice Grace refused to allow him to do so, setting aside the compensation and termination provisions based on:

• The decision-making process that had led to the 2008 MCA
• The unfairness of the actual terms of the agreement (a topic discussed further in the next section of this chapter)¹²

The lesson from Mr. Conn's case is that approval of a Compensation Committee¹³ is not sufficient for an appropriate decision-making process. In Mr. Conn's case, there were a couple of different problems with the Compensation Committee approval.

First, he was friends with the head of the Compensation Committee—which, in light of the agreement being unfairly in Mr. Conn's favor, raised serious concerns about how neutral and effective the Compensation Committee had been.

Second, the comparators the Committee used compared dissimilar things.¹⁴ A compensation committee should be utilizing multiple comparators to determine what the appropriate compensation for any given individual should be—but in Mr. Conn's case, some even post-dated the 2008 MCA and therefore could not have been known before the agreement was signed.¹⁵

Justice Grace found there was no due diligence, negotiation, or outside advice, nor had anyone considered the best interests of Ontex.¹⁶

This means that in His Honor's view,

98 … 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.¹⁷

Justice Grace held that as a principle of law, a contract “flowing from a breach of the required standard may be set aside by the court in whole or in part,”¹⁸ something that is discussed further in “If Your Company May Have an Executive Who Breached Their Duty, Contemplate Asking a Court to Set It Aside” of this chapter. That is what happened to Mr. Conn: He might have negotiated an excellent MCA, but in the end it did absolutely nothing for him.

If It Looks Too Good to Be True, a Court Is Probably Going to Feel the Same Way

For a fiduciary to negotiate an agreement that was unfair to the corporation and unreasonable¹⁹ is a breach of the required standards. At the end of the day, process aside, any deal struck must be fair and reasonable in the circumstances.

In Mr. Conn's case, even aside from the lack of transparency, the Court held it was unreasonable:

152 The provisions to which I have referred were unfair and unreasonable … 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.

153 … 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.

The compensation and termination provisions of Mr. Conn's agreement were therefore set aside.²⁰ Mr. Conn had also committed other breaches of his fiduciary duties. For example, Mr. Conn had allowed his personal interests in an internal power struggle to govern over the duties he owed to the corporation, including offering employees' contracts on Goldstone's behalf that helped cement his position.²¹

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

How do you determine if something is unreasonable? Think like a court: What do other similar companies give their executives?

Similarly, a golden-parachute clause can badly backfire on the executive who relied on it to take them to safety. These are generous severance packages meant to kick in when there is a change of management, a sale of the business, or other such circumstances.

On one hand, for a longstanding executive or board member, a generous termination provision might make sense. On the other hand, a golden parachute can also be a breach of fiduciary duties, an unenforceable penalty, and unconscionable and oppressive.

In Zielinski v Saskatchewan (Beef Stabilization Board),²² Alvin Zielinski was an employee of the Saskatchewan Department of Social Services earning $64,000 per year (para 2). He obtained a one-year leave from his job to take an opportunity to assist the Beef Stabilization Board with a re-organization as Manager of Finance and Administration (paras 3–4).

After the departure of the board's general manager, Mr. Zielinski negotiated with the board to take over that position; the agreed-to contract, among other provisions, contained a golden-parachute clause, although it could be terminated on 90 days' notice provided Mr. Zielinksi would then be entitled to a “retiring allowance” equal to 2.5 times his annual remuneration (para 12).

After his termination, therefore, Mr. Zielinski sued for the golden parachute amount. However, it was not to be: Rather than getting his agreed-to amount, the court determined the lump sum to be extravagant and unconscionable, and was an unenforceable penalty.²³ This was because it bore no resemblance to Mr. Zielinski's actual damages (considering the massive sum and the fact the amount would be paid whether Mr. Zielinski worked 1 day or 50 years), and was obviously instead a penalty for the employer.²⁴

Mr. Zielinski was instead awarded $8,400.

Don't Stop Being Scrupulously Honest Just Because a Contract Is Signed

So, you've negotiated your compensation. It is fair, you've had a transparent process, and neither the shareholders nor the media are out for your blood. Well done!

But you're not done yet. During your compensation from the company—and after, for that matter—scrupulous honesty is key.

George Sookochoff had 30 years of experience in junior mining companies and was an expert in data management services.²⁵ In 2006, Sookochoff started working with PBX Ventures Ltd. (“PBX”), assuming a position as a director of PBX on August 9, 2006; two years later, on February 4, 2008, he became CEO, and by July 8, 2008, he became CEO and president.²⁶

Through his company, Geocomp, he had entered into a management agreement with PBX as of January 2010; in June 2010 the agreement was extended until May 31, 2011.When the initial management agreement was made Mr. Sookochoff did not vote on the agreement.²⁷ However, after the management agreement expired, Geocomp continued to invoice PBX, and the invoices were paid largely by checks signed by Mr. Sookochoff's subordinates.²⁸

PBX was insolvent by June 2012.²⁹ On June 25, 2012, Mr. Sookochoff resigned as president, but continued as CEO;³⁰ the board granted stock options to him on that same day, and held that PBX would not enter any management or employee contracts until it was in better financial position.³¹ Mr. Sookochoff was responsible, as CEO, for addressing reduction of salary and contract costs.³²

An investor who was willing to provide emergency funding during the time dictated that the money could not go to salaries, and the president of PBX understood, after a conversation with Mr. Sookochoff, that Mr. Sookochoff would not receive remuneration during the financial instability.³³

In October 2012, Geocomp invoiced PBX for services from July through October 2012.³⁴ Mr. Sookochoff did not raise with senior management that his management contract had expired, and therefore senior management was under the mistaken impression that Mr. Sookochoff had a contractual right to be paid.³⁵

The court held that Mr. Sookochoff breached his fiduciary duties of loyalty and avoidance of conflict of interest when he continued to invoice PBX and did not disclose that the management agreement had expired.³⁶ Mr. Sookochoff claimed that the money was rightfully paid to him based on quantum meruit; the court found that Mr. Sookochoff had breached duties of loyalty and good faith to disclose the expiry of his contract and thus had no reasonable expectation of repayment for services invoices after June 2012.³⁷ He was therefore denied recovery under quantum meruit.³⁸

Justice Pearlman determined that Mr. Sookochoff had performed about $100,000 in services for PBX—so he got to keep that amount, but the court ordered that the remainder of the fees paid to him must be disgorged.³⁹

Not only must the contract be negotiated fairly, therefore, it also must be performed fairly. Anything less than scrupulous honesty, and executives might find themselves on the wrong end of the law.

If Your Company May Have an Executive Who Breached Their Duty, Contemplate Asking a Court to Set It Aside

Although no one wants to be Ronald Goegan or Gary Conn, it can be an equally difficult place to be for shareholders, directors, or officers who have inherited a company which seems to have had an executive compensation problem. If something seems problematic, the company will need to move swiftly to ask a court to set the offending contract aside.

In Gary Conn's case, the court set aside the agreement in its entirety as unfair—and that isn't the only case where a court has done so in response to breaches of fiduciary duties.

Goldstone follows two earlier and similar Ontario Court of Appeal cases: Unique Broadband Systems and UPM-Kymmene. In both cases, a senior executive breached their fiduciary duties in negotiating their compensation or contracts and the court determined that those agreements should be set aside.

In the 2014 Ontario Court of Appeal decision of Unique Broadband Systems Inc., Re,⁴⁰ Gerald McGoey became a director and acting CEO of UBS in 2002. Executive compensation at UBS included an incentive-driven share appreciation rights (SAR) plan.⁴¹

In 2009, UBS's subsidiary sold a telecommunications spectrum and the UBS board of directors resolved that this would count as a triggering event for the SAR plan.⁴² McGoey was one of three UBS board members who made up the UBS compensation committee⁴³—which, in hindsight, was an obvious problem that could, and should, have been ameliorated by ensuring McGoey was removed from any decision that could affect his own compensation.

In 2009 the board canceled share appreciation rights (SAR) units and set up two pools:

1. A SAR cancellation payment pool; under that pool McGoey and three other directors would receive SAR cancellation awards, which, for McGoey, was worth $600,000⁴⁴
2. A bonus pool under which McGoey was to receive $1.2M in bonuses⁴⁵

The shareholders protested these changes. This resulted in the removal of the directors and McGoey's resignation as CEO, in which he took the position that he was terminated without cause.⁴⁶ McGoey had earlier negotiated a golden parachute or “enhanced severance” clause in his contract; it was worth $9.5M, and the only restriction on the provision was a narrow definition of “for cause” termination. McGoey sued for that amount⁴⁷ as well as the SAR cancellation award and bonus payments.

The Court was less than receptive to McGoey's claims. As CEO and director, the Court of Appeal held that McGoey owed UBS fiduciary duties which:

included an obligation to act in good faith and in the best interests of the corporation. He had a specific obligation to scrupulously avoid conflicts of interest with the corporation and not to abuse his position for personal gain …⁴⁸

The SAR Cancellation Award and bonus pool awards were set aside by the court, which found that McGoey's actions in establishing both were “driven by self-interest, unsupported by any reasonable or objective criteria, and contrary to the best interests of UBS.”⁴⁹

Although the trial judge had allowed McGoey to rely on the golden-parachute clause to claim enhanced severance, the Court of Appeal disagreed.

A director cannot contract out of their statutory duties to act honestly, in good faith, and in the best interests of the company under the Ontario Business Corporations Act,⁵⁰ and the contract terms could not allow Mr. McGoey to escape “his obligation to act in [sic] manner that is consistent with his duties under the legislation (i.e., he could breach his fiduciary duties to the company).”⁵¹

The Court of Appeal held that, read as a whole, the agreement sought to ensure that default was constrained to serious misconduct that was injurious to UBS; a serious breach of fiduciary duty would meet that definition.⁵² Despite the narrow “cause” terms in the contract, therefore, the Court of Appeal held that the breach of fiduciary duty would deprive Mr. McGoey of the benefit of the enhanced severance term.

A third case, UPM-Kymmene Corp v UPM-Kymmene Miramichi Inc.,⁵³ was decided by Justice Lax in 2002 and affirmed by the Ontario Court of Appeal in 2004. In UPM, the plaintiff, Mr. Berg, was a lawyer⁵⁴ who was brought into the corporation as chairman of the board of directors.⁵⁵

Mr. Berg then sought a very generous compensation package.⁵⁶ At the first board meeting, Mr. Berg's proposed package was not accepted and there was heavy resistance from the board.⁵⁷ At a second board meeting—between which time members had resigned or changed over—the board rubber-stamped the agreement.⁵⁸ Mr. Berg, however, had not provided the new board with the materials showing the previous board's discomfort with the compensation package.⁵⁹

The second board had an opinion provided by a compensation consultant; however, again, as in UBS, that could not save the agreement. The court found that the consultant had had limited time to review, provided only high-level observations, and was unaware of some information, including that there had been prior resistance to the compensation package.⁶⁰

Justice Lax determined that: (1) Mr. Berg breached his fiduciary duties in the way he negotiated and presented the agreement and (2) the board failed to establish a reasonable process such that the contract was not fair or reasonable.⁶¹

UBS holds that disclosure by a fiduciary must be clear and complete, such that the board is made aware of, as Justice Lax stated it, “the real state of things.”⁶²

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” … 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.⁶³

The disclosure of a director's interest in a transaction is, therefore, only the very first step.⁶⁴

Mr. Berg's conduct, in providing inadequate disclosure, was to the Court “exactly opposite” to what was required of Mr. Berg as a fiduciary:⁶⁵

123 Mr. Berg failed utterly in his duties to Repap. His own self-interest prevailed. His conduct was exactly opposite to the conduct that the law required of him as a fiduciary—disclosure, honesty, loyalty, candour, and the duty to favour Repap's interest over his own …

The court agreed with the defendants that setting aside the agreement was the proper remedy, the agreement having been “procured through a breach of fiduciary duty.”⁶⁶

So, if you've just come into a company that appears to have a serious executive compensation problem, there is hope—the courts appear to be consistently moving toward solutions that are increasingly responsive to the problem at issue. Remember, however, that it is always worth the time and effort involved to avoid the problem in the first place—so these should only be last-ditch measures should an unfair executive compensation package make it past your well-structured and transparent system.

Conclusions and Lessons from the Law

If you are seeking to avoid the fates of those depicted in this chapter, here's what we would suggest:

1. Create a proper compensation committee. The people making the decisions should not be the ones benefiting from them. The Compensation Committee should be selected from the board and outside individuals who can provide proper oversight.
2. Hire an outside consultant. Wage and severance packages should be determined in line with comparable companies. An outside expert can help a compensation committee.
3. Give the committee an adequate amount of time to make decisions. A rushed decision is a decision that can be attacked for inadequate thought and improper weighing of different factors.
4. When voting, board members should be scrupulously careful to avoid conflicts of interest. To protect both themselves and the company, any board members with a conflict of interest should recuse themselves from a given vote.
5. A company should consider suing for disgorgement of funds paid out if it turns out that a past executive took advantage of the company. If you find yourself realizing that your new acquisition has some questionable contracts, there may still be a remedy. You'll want to quickly contact counsel to discuss whether it is still possible for the company to stem any losses.

About the Authors

A well-known and widely quoted authority on employment law in Canada, Howard Levitt writes a weekly employment column in the National Post, hosts a weekly talk show on employment law on Newstalk 1010 CFRB, and is the author of one of Canada's leading dismissal textbooks, The Law of Dismissal in Canada. He has also authored five other texts and is editor-in-chief of the national law report, the Dismissal and Employment Law Digest, which covers every notable dismissal and employment law case in Canada.

Howard, as senior partner at Levitt LLP, has appeared as counsel on labor and employment cases at all levels of court in Ontario and across Canada, including the Supreme Court of Canada and three provincial courts of appeal as well as the Federal Court of Appeal. He has also lectured extensively, lobbies at the federal and provincial level regarding labor legislation, and regularly chairs labor and employment law conferences across Canada.

An associate at Levitt LLP, Allyson Lee has appeared before multiple courts and tribunals representing employers and employees, including all levels of court in Ontario (Superior Court, Divisional Court, and Court of Appeal), the Workplace Safety Insurance Appeals Tribunal, and the Human Rights Tribunal of Ontario. Prior to joining Levitt LLP, Allyson clerked for a judge at the Federal Court of Canada.