Earlier this year, the Ontario Court of Appeal decided Unique Broadband Systems, Inc. (Re), in which it overturned the trial judge’s decision to award the former CEO of Unique Broadband Systems (“Unique”) severance and upheld the lower court’s decision not to award the former CEO certain additional compensation and indemnify him for his legal fees. The Court of Appeal decision is relevant to charitable and non-profit corporations because of what it says about compensation decisions and about director indemnification.
The CEO of Unique had a contract that entitled him to indemnification for legal fees incurred in defending himself against Unique-related claims in certain circumstances. He was also entitled to compensation related to the price of Unique’s shares.
When a transaction to sell an indirect asset of Unique did not result in the increase to Unique’s share price that the CEO and other directors expected, the board decided to cancel the compensation plan and pay each director roughly the amount that each of them would have received had the hoped-for share price occurred. The directors each declared a conflict of interest and then voted for the change. The total of all compensation to be paid to directors and officers under this and other associated payments was 97.6% of the market capitalization of Unique.
The shareholders of Unique did not accept the compensation changes and held a special meeting at which they removed all directors. The CEO treated his removal from the board as termination without cause, triggering a termination payment obligation. He then sued Unique for $9,500,000.
The Court of Appeal considered the compensation changes and concluded they were in breach of the board’s fiduciary duty. The fiduciary duty of a board of directors requires the board to act in good faith and in the best interest of the corporation, to avoid conflicts of interest and to refrain from abuse of the position for personal gain. The Court concluded that these elements of the board’s fiduciary duty had not been met. In particular, the Court pointed to the absence of any advice from compensation consultants on the reasonableness of the changes. While Unique’s lawyer had been asked some general questions about compensation, he was not aware of quantum and had never opined on reasonableness.
The fiduciary standards applicable to non-profit corporations would generally be similar to those applicable to Unique. While non-profit (but not charity) directors can be compensated, compensation must be reasonable. Particularly where there are no disinterested directors, compensation should be set with the advice of outside experts.
The fiduciary standards applicable to most incorporated charities in common law provinces are higher than those for Unique. Generally speaking, a charity director in common law Canada should not be paid for serving as a director, or in any other context, absent an approving court order. Any compensation paid by a charity must be reasonable and expert advice is recommended if there is any question about reasonableness.
The Court of Appeal refused to indemnify the CEO for legal fees in this dispute because he had breached his fiduciary duty to Unique. While most charity and non-profit by-laws contain indemnity provisions and many charity and non-profit organizations purchase director and officer liability insurance, directors should not expect to rely on these if they breach their fiduciary duty. Regardless of what a corporation’s by-laws state, indemnity is likely not available in the absence of the director having acted honestly and in good faith with a view to the best interests of the corporation.