Executive’s Self-Dealing Can Lead to Rescission of Employment Agreement

November 2017

Article by: Maggie Campbell

Previously printed in the LexisNexis Labour Notes Newsletter.

The focus of this article is a case arising out of Ontario: UPM-Kymmene Corp. v. UPM-Kymmene Miramichi Inc., [2002] O.J. No. 2412 (S.C.J.), affirmed [2004] O.J. No. 636 (C.A.).

At the heart of this oppression remedy case was a very generous executive employment agreement that put the personal interests of a fiduciary ahead of those of the company he was supposed to serve. The decision in the case provides an interesting example of an extreme failure of an executive to act in accordance with his fiduciary duties and the potential consequences that can flow as a result.

Steven Berg was a corporate director of the plaintiff and also the company’s largest individual shareholder. He sought to make himself Senior Executive Officer (“SEO”) and, to this end, he had a lucrative employment agreement prepared for him in his new role.  The agreement provided for a five-year term with renewals, along with significant benefits such as a signing bonus of 25 million shares and a stock option grant of a further 75 million shares (which amounted to approximately 10 percent of the total value of the shares).  Importantly, Mr. Berg’s agreement also included liberal change of control and termination provisions which essentially called for him to be made whole to the end of the five-year term.

At the time that Mr. Berg was seeking to make himself SEO, the company was in a cash constrained position and was just starting to emerge from a period of financial crisis. There were already three executive officers in place and Mr. Berg did not bring any particular skills or expertise to the company.  In short, the company did not need him and could not afford him.

Nonetheless, Mr. Berg pushed his employment agreement with the board of directors, which was constituted entirely of newly appointed members. The board did engage an independent consultant to provide advice on the agreement.  She, however, was not made aware of many of the material facts and the opinion prepared was high level only.  While there was significant opposition to Mr. Berg’s agreement (some of the board members even resigned over the issue), the board ultimately approved the arrangement and appointed him SEO.

After a change of control, Mr. Berg’s employment ended and he brought an action against the company for damages totalling $27,000,000 in respect of the compensation provided in his agreement. At the time of his dismissal, he had only worked for the company for seven months and had already been paid $200,000.

The company brought an oppression claim under section 241 of the Canada Business Corporations Act, R.S.C. 1985, c. C-44, seeking to have Mr. Berg’s employment agreement rescinded.  The trial judge found that the extraordinarily generous package which Mr. Berg had  secured for himself was detrimental to the company’s interests and created an enormous liability that it could not afford.  Mr. Berg did not comply with his fiduciary duty to act honestly and in good faith with a view to the best interests of the company.  In fact, his actions were found to be motivated by greed and self-interest alone and to be the exact opposite of what was required of him as a fiduciary.  The trial judge determined that the substantial unfairness of the agreement warranted the granting of the equitable remedy of rescission, and the agreement was set aside.

The Ontario Court of Appeal upheld the decision, finding that the trial judge properly invoked the oppression remedy to rectify Mr. Berg’s prejudicial self-dealing. The Court found that the trial judge did not substitute her own view of reasonableness of the compensation package for that of the company’s board of directors.  Rather, she properly determined that the contract approval process had been seriously flawed and that the board’s decision fell outside the range of reasonableness.

This decision provides an extreme example of self-dealing, but underscores the importance of executives and directors acting in accordance with their fiduciary duties by putting the interests of the company above their own. This decision also highlights the importance of ensuring that executives and other fiduciaries are not involved in determining their own employment agreements or compensation packages, and instead that these matters are dealt with diligently and prudently by the board of directors.