Materials for a Presentation by Sandra Sbrocchi, McMillan LLP June - - PDF document

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Law Society of Upper Canada The Six-Minute Business Lawyer 2010

Materials for a Presentation by Sandra Sbrocchi, McMillan LLP June 1, 2010

Lawyer Directors: Recent Developments and Risks

Introduction A recent securities class action certification ruling of the Ontario Superior Court

• f Justice, Allen v. AspenGroup Resources Corporation, et al.1 (the “Allen Case”) has raised

concern regarding the potential liability of law firms, where a law firm’s partner acts as both a director of a corporation and legal counsel to such corporation. The Allen case provides an

• pportunity to discuss this potential liability of law firms and other risks associated with a lawyer

serving on the board of directors of a corporate client of its firm including a potential conflict of interest, loss of solicitor client privilege and statutory and common law liability in respect of directors’ duties. This paper (i) summarizes the Allen Case and its effects on law firms; (ii) discusses other risks as noted above; and (iii) sets out certain protective measures for law firms, lawyers and corporations in connection with a lawyer serving on a corporate board and acting as legal counsel to such corporation. The Allen Case The Allen Case involved a class action claim for damages on behalf of shareholders of Endeavour Resources Inc. (“Endeavour”) due to alleged misrepresentations in a takeover bid circular (the “Circular”) sent to all of the shareholders of Endeavour by Aspen Group Resources Corporation (“Aspen”), a Yukon oil and gas corporation. In 2001, Endeavour was acquired by Aspen in a securities exchange takeover transaction, whereby the shareholders

• f Endeavour tendered their securities in Endeavour to Aspen in exchange for securities of

Aspen, in accordance with the terms of the Circular.

• Mr. Charles Allen (“Allen”), a former Endeavour shareholder and director,

alleged that the Circular contained misrepresentations regarding management and financial

1 (2009) CarswellOnt 7260.

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reporting and failed to disclose that the insiders of Aspen had engaged in improper self dealing. As a result, Allen claimed that Endeavour shareholders received Aspen shares that were over- valued and were entitled to damages from Aspen, its directors and certain officers, its auditors and its law firm, WeirFoulds LLP. WeirFoulds acted as legal counsel to Aspen and provided legal advice in connection with the take-over of Endeavour. Mr. Egan, a partner of WeirFoulds, advised Aspen concerning the take-over transaction and also served on the board of directors of Aspen. The plaintiff brought a cause of action pursuant to Section 131(1)(a) of the Ontario Securities Act2 (the “OSA”) against the directors of Aspen, including Mr. Egan in his capacity as a director, for alleged misrepresentations and non-disclosures of material facts in the

• Circular. The plaintiff also made common law claims against each of Mr. Egan and WeirFoulds

in negligence and a claim that WeirFoulds was vicariously liable for Mr. Egan’s statutory liability as a director. The basis for the alleged statutory liability of the law firm was that Mr. Egan was acting in the ordinary course of the business of the firm, both in his capacity as a director of Aspen and in his legal work in the preparation of the take-over bid documentation. WeirFoulds submitted that in signing the circular in his capacity as a director, Mr. Egan was not acting in his capacity as a lawyer or as a partner of the firm. It argued that to hold a law firm liable for its partner’s actions as a director would have a chilling effect on the legal profession and would result in a nationwide flood of resignations of directorships. However, WeirFoulds conceded that a law firm could potentially have liability for the actions of one of its partners qua director if, in carrying out his or her duties as a director, he or she was carrying on the usual and

• rdinary course of business of the law firm.

The court granted an order certifying the action brought under Section 131(1) of the OSA as a class proceeding pursuant to Class Proceedings Act3. In rendering its decision, Justice Strathy concluded that it is possible that a law firm could be held liable for a partner’s statutory liability as a director pursuant to 131(1)(a) of the OSA where one of the firm’s partners provides legal advice to a client corporation and also sits on the board of such corporation with a view to increase the firm’s profile and business and improve the relationship with the client, thereby acting in the ordinary course of business of the firm. Specifically, the court commented: It seems to me that it is arguable that a lawyer who, through his or her law firm, acts as external corporate counsel to a corporation and who sits on the corporation’s board, may well be acting in the

• rdinary course of the law firm’s business when he or she takes a

seat at the boardroom table. Indeed, such a relationship with the corporation may be encouraged by the law firm to strengthen the relationship with the client, to raise the profile of the lawyer and the law firm and to increase business. To the extent there are risks

2 R.S.O. 1990, c. S.5. 3 1992, S.O. 1992, c. 6.

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for the lawyer and the law firm, they undoubtedly can be offset by appropriate liability insurance. Accordingly, the court concluded that, at this stage, it could not be ruled out that WeirFoulds’ liability for the actions of Mr. Egan, both for common law negligence and as a director, were unsustainable at law given his actions were consistent with the ordinary course of business of the law firm. Specifically, the court concluded: Recognizing that the inquiry at this stage is unrelated to the merits, I cannot say that the claim that WeirFoulds is liable for the actions

• f Mr. Egan, both as a director and for common law negligence, is

unsustainable in law. The defendants have sought leave to appeal. Although not a merits based decision, the conclusion reached by Justice Strathy in the Allen Case demonstrates that a law firm should exercise care and clarity when one of its partners serves as a director of a corporation that is also a client of the firm. Other Risks The Allen Case serves as an opportunity to identify certain other risks associated with lawyers serving on boards of corporate clients, including the potential of (i) a conflict of interest causing a violation of the rules of professional conduct; (ii) loss of solicitor client privilege; and (iii) statutory and common law liability in respect of directors’ duties. (a) Conflicts of interest If a lawyer acts as a director of a corporate client and acts as external legal counsel to such client, there is a risk that he or she may confront a conflict of interest. Taking on the dual role of legal advisor and director in essence makes the lawyer-director his or her own client.4 This may have an adverse effect on the lawyer’s behaviour as legal advisor. For instance, the lawyer may be more conservative when advising on potential legal risks knowing that he or she will be personally affected by the consequences. This may lead the lawyer-director to oppose corporate action that is otherwise legitimate and warranted in the circumstance.5 It is also possible that the lawyer-director may identify too closely with the corporation resulting in the impairment of his or her ability to give independent and impartial

4 Patrick W. Straub, “ABA Task Force Misses the Mark: Attorneys Should Not be Discouraged from Serving on Their

Corporate Client’s Board of Directors” (2000) 25 Del. J. Corp. L. 261 at 264 [Straub].

5 Ibid.

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legal advice.6 If the board of directors rejects the lawyer’s business advice as a director, the lawyer must still continue to provide legal advice on the subject matter and may have to represent the corporation on the matter.7 This may lead to the deterioration of the lawyer-client relationship. A conflict of interest may arise when the board is deciding whether to retain counsel for an impending dispute or when discussing legal fees.8 The lawyer-director may use this as an opportunity to obtain more legal work for his or her firm and may push for high fees to be paid.9 The lawyer-director may even discourage the corporation from seeking legal services from another firm that may be better suited to advise the corporation on particular matters.10 Additionally, there is a possibility that the firm will be disqualified from representing the corporation in litigation where the lawyer-director is named as a defendant or is called as a witness.11 If the firm has a long history of representing the client and knowledge of its affairs, this could greatly disadvantage the client.12 Furthermore, being caught up in lengthy litigation as a defendant may have a negative impact on the reputation of the lawyer and the firm. The consequences of a conflict of interest include a breach of the lawyer’s duties under the Rules of Professional Conduct (the “Rules”) as well as a breach of fiduciary duties

• wed to the corporation.13 Under Rule 2.04(3), lawyers have a responsibility to avoid acting in a

manner where there is or is likely to be a conflict of interest. The commentary to Rule 2.04(3) provides: A conflict of interest may arise when a lawyer acts not only as a legal advisor but in another role for the client. For example, there is a dual role when a lawyer or his or her law firm acts for a public

• r private corporation and the lawyer serves as a director of the

corporation… A dual role may raise a conflict of interest because it may affect the lawyer’s independent judgment and fiduciary

• bligations in either or both roles, it may obscure legal advice from

business and practical advice, it may invalidate the protection of lawyer and client privilege…

6 Catherine Francis, “The Lawyer as Director: Benefits and Pitfalls” (Ontario Bar Association Continuing Legal

Education, 30 November 2004) at 18 [Francis]

7 Straub, supra note 4 at 265. 8 Straub, supra note 4 at 265. 9Francis, supra note 6 at 17. 10 Ibid. 11 Ibid. at 18; See also the commentary to Rule 2.04. 12 Ibid. at 19. 13 Ibid. at 17.

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Rule 6.04 states that a lawyer who engages in another profession, business, or

• ccupation concurrently with the practice of law shall not allow the outside interest to jeopardize

the lawyer’s professional integrity, independence, or competence. Further it provides that a lawyer shall not allow involvement in an outside interest to impair the exercise of the lawyer’s independent judgment on behalf of a client. The commentary to Rule 6.04 provides that a lawyer acting as a director of a client corporation is an outside interest that could compromise a lawyer’s professional integrity and judgement. Being a director of a client corporation may also interfere with the lawyer’s

• bligation under Rules 2.02(5.1) and (5.2) to act as a “whistle-blower” and report conduct up the

ladder of responsibility within the corporation that is dishonest, fraudulent, criminal or illegal.14 Additionally, the lawyer-director may breach the duty of confidentiality it owes to the corporation by using information obtained at directors’ meetings to secure more legal work.15 If the board adopts a written code of business conduct and ethics, which includes reporting illegal and unethical behaviour, this may conflict with the lawyer-director’s obligation to keep all information concerning the affairs of the client in strict confidence.16 (b) Loss of Solicitor-Client Privilege There is a danger when a lawyer sits on a corporate client’s board of directors that solicitor-client privilege may be lost. Solicitor-client privilege attaches to communications (a) between a client and his or her lawyer when the lawyer is acting in his or her professional capacity as a lawyer; (b) given in the context of obtaining legal advice; and (c) intended to be confidential.17 Communications that occur when the lawyer is acting as a director are not

• privileged. It is likely that communications between the lawyer-director and the corporation will

involve a mix of business advice, legal advice and general strategy. This may make it difficult to discern when legal advice is being given which could result in the loss of privilege. (c) Liability Risks – Statutory and Common Law Duties for Directors

14 The commentary to Rule 2.02(5.1) and (5.2) provides: Once a lawyer acting for an organization learns that the

• rganization has acted, is acting, or intends to act in a wrongful manner, then the lawyer may advise the chief executive
• fficer and shall advise the chief legal officer of the misconduct. If the wrongful conduct is not abandoned or stopped, then

the lawyer reports the matter “up the ladder” of responsibility within the organization until the matter is dealt with

• appropriately. If the organization, despite the lawyer’s advice, continues with the wrongful conduct, then the lawyer shall

withdraw from acting in the particular matter in accordance with rule 2.09. In some but not all cases, withdrawal would mean resigning from his or her position or relationship with the organization and not simply withdrawing from acting in the particular matter.

15 Francis, supra note 6 at 18. 16 Alan L.W. D’Silva, Partick O’Kelly and Ellen M. Snow, “Lawyers on Boards: Assessing the Risks and Limiting the

Liability” LAWPRO Magazine 6:2 (Summer 2007) [D’Silva, O’Kelly and Snow]. However, Rule 2.03 allows a lawyer to disclose information where it is “expressly or impliedly authorized to do so” and it is possible that a code of business conduct would fall under this exception to confidentiality.

17 See Solosky v. The Queen, [1980] 1 S.C.R. 821.

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When choosing to become a director of a client corporation, a lawyer must consider the potential personal liability associated with the role. The statutory duties of directors are provided in the Canada Business Corporations Act18 (the “CBCA”) as follows:

• 122. (1) Every director and officer of a corporation in exercising

their powers and discharging their duties shall (a) act honestly and in good faith with a view to the best interests

• f the corporation; and

(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. Section 122(1) of the CBCA imposes two distinct duties on directors, a fiduciary duty and a duty of care. The fiduciary duty focuses on the subjective motivations of directors.19 A director must avoid conflicts of interest, avoid enriching themselves at the corporation’s expense and maintain confidentiality of information.20 An objective standard is used in considering the duty of care that must be met by

• directors. Director’s actions should be compared to a hypothetical “reasonably prudent person”.

However, a court may still take into consideration a lawyer’s subjective personal knowledge. In YBM Magnex International Inc.21, the Ontario Securities Commission stated that there may be a higher standard of care for lawyer directors on legal matters as the lawyer-director may be in a better position to assess the materiality of certain facts.22 A director’s liability extends beyond the specific duties in the CBCA.23 For example, directors have liability under s.130 of the OSA24 for misrepresentation in a prospectus and under s.131 of the OSA, as in the Allen Case, for misrepresentations in takeover bid circulars.

18 R.S., 1985, c. C-44. 19 Peoples Department Store Inc. (Trustee of) v. Wise [2004] 3 S.C.R. 461, 244 D.L.R. (4th) 564 • 4 C.B.R. (5th) 215

[Peoples].

20 Francis, supra note 6 at 2. 21 (Re) (2003), 26 OSCB 5285 at para. 185. 22 However, this decision relied on Soper v. the Queen (1998), 97 DTC 5226 (F.C.A) which was not followed by the SCC

in Peoples. The case does suggest, however, that Canadian courts may be leaning towards a more subjective test which takes into account the lawyer-director’s substantive knowledge. However, the Ontario Securities Commission was not analyzing the directors’ duties under the CBCA but only mentioned them as part of its larger discussion of the due diligence defence under the Ontario Securities Act.

23 A lawyer-director will be subject to liability under tax law, environmental law, labour and employment law, and

bankruptcy law among others.

24 R.S.O. 1990, c. S.5.

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Protective Measures Although there are several risks associated with a lawyer serving on the board of directors of a corporate client and providing legal advice to such client, there are a number of benefits for both the law firm and the corporate client, which include25: (i) strengthening the firm’s ties to the client; (ii) keeping the firm better informed of the client’s business affairs; (iii) improving the lawyer’s credibility with the client; (iv) prestige for the lawyer and his or her firm; and (v) assisting the lawyer in developing corporate contacts outside of the corporation for which he or she is a director which is likely to generate business for the firm. Benefits for the corporate client include:26 (i) meeting minimum residency requirements for foreign controlled corporations; (ii) using the incorporating lawyer-director’s law firm address as a corporation’s local head office address; (iii) having the lawyer act as a local point person for receiving legal notices; and (iv) overall more sophisticated and knowledgeable board and enhanced quality of board decisions. Law firms and corporations should undertake a review of their policies and practices in respect of the role of a law firm partner as both a member of the board of directors of a corporation and legal counsel to a corporation so that the benefits outweigh the risks. There are a number of ways to minimize the risks noted above. (1) Make sure the corporation is informed The lawyer-director should ensure that the corporation is aware of the potential conflict of interest in respect of the dual role.27 The client should be informed of the potential loss of solicitor-client privilege and the loss of the opportunity to have the law firm represent their interests if proceedings are commenced.28 The corporation should also be informed that it is unlikely that the lawyer-director will be seen as an independent director.29 This may be an important consideration for a corporation that is trying to fill its independent director seats. Providing the client with this information will enable the corporation to make an informed business decision as to whether having a lawyer-director would be profitable for the corporation.

25 Straub, supra note 4 at 263. 26 Francis, supra note 6 at 16. 27 D’Silva, O’Kelly and Snow, supra note 16. 28 Karen K. H. Bell and Duncan D. Gosnell, “The Lawyer as Director: Mercenary or Cannon Fodder” (Canadian Bar

Association Continuing Legal Education, 7 May 1999) at 7 [Bell and Gosnell].

29 National Policy 58-201 entitled “Corporate Governance Guidelines” (which has been adopted in Ontario) defines an

“independent director” as someone who has “no direct or indirect material relationship” with the corporation. A “Material relationship” is defined as one “which could, in the view of the issuer’s board of directors, reasonably interfere with the exercise of a member’s independent judgment”. The definition provides that payment to an entity that gives legal services in which the director is a partner constitutes a material relationship; See also D’Silva, O’Kelly and Snow, supra note 21.

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The client should be made aware that having a lawyer participate at board meetings as an advisor may be just as beneficial to the corporation.30 (2) Abstain from participating in matters concerning choice of legal counsel and legal fees As mentioned above, a conflict of interest can arise when a lawyer-director participates in a board meeting concerning choice of legal counsel for impending legal proceedings or legal fees. To avoid this, the lawyer-director should not participate in any board discussion concerning lawyer fees, selection of counsel for particular tasks, and other situations in which the lawyer-director or his or her firm may have an interest.31 (3) Make efforts to ensure that solicitor-client privilege is not compromised The lawyer-director needs to ensure that business advice and legal advice are clearly separated. In order to do so, the lawyer-director should clarify whether questions from

• ther directors are being asked in the lawyer-director’s business or legal capacity.32 When

responding to questions, the lawyer-director should state clearly whether he or she is providing legal advice or business advice.33 The lawyer-director should also review draft minutes of meetings to ensure that any legal advice has been properly identified.34 This will make it easier to defend a privilege claim in subsequent litigation. It would also be prudent for the lawyer- director to advise the other directors to restrict access to the minutes of the meetings and the supporting documents to protect confidentiality.35 In addition, documents that are confidential or contain legal advice should be properly marked to avoid ambiguity.36 (4) Seek appropriate indemnification and insurance protection Section 124 of CBCA allows a corporation to indemnify its directors for all costs and expenses reasonably incurred by the director in defending and/or settling a law suit. In order to benefit from an indemnification, the director must have been acting honestly and in good faith and if the proceedings are criminal or administrative, the director must have reasonable grounds for believing the conduct was lawful. In the context of criminal or administrative proceedings it will be difficult to argue that the lawyer-director reasonably believed the conduct to be lawful due to his or her subjective legal knowledge. Even if the lawyer-director’s conduct falls within

30 Bell and Gosnell, supra note 29 at 7. 31 Ibid. at 8; Straub, supra note 4 at 271. 32 Straub, supra note 4 at 271. 33 Ibid. 34 D’Silva, O’Kelly and Snow, supra note 16 at 4. 35 Micalyn S. Harris and Karen L. Valihura, “Outside Counsel as Director: The Pros and Potential Pitfalls of Dual Service”

(1998) 53 Bus. Law 479 at 504.

36 Ibid. at 504.

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what is covered by the indemnification, if the directors are exposed to a claim upon the insolvency of the corporation, this indemnification will not provide much protection.37 It is important for the lawyer-director to ensure that they will be covered by D&O insurance since LawPro insurance does not cover activities as a director and an indemnification from the corporation does not provide reliable protection. The extent of LawPro’s protection was discussed in Kerr v. Lawyers’ Professional Indemnity Co.38The issue in this case was whether LawPro had to cover a lawyer’s liability where the lawyer was acting in an administrative capacity as corporate secretary. If the claim had related solely to his role as corporate secretary he would not have been entitled to his legal insurance. However, the allegations were related to the lawyer’s role as corporate-secretary as well as legal counsel. Since a claim could be made in connection with his role as a lawyer, he was entitled to insurance. This case illustrates the importance of D&O insurance as the lawyer-director will not have adequate protection if a court decides that he or she acted as director of the corporation and not as the corporation’s legal counsel. There are limits to D&O coverage as well. In general, D&O carriers do not protect the insured against liabilities arising from acts in any other capacity, whether as a lawyer

• r in some other professional capacity.39 There are a wide variety of D&O policy terms, the

lawyer-director should ensure he or she is informed of what kind of D&O insurance the corporation offers, if any.40 The lawyer-director may also want to impose as a condition of directorship that the corporation provide indemnification and maintain sufficient levels of D&O insurance for this purpose.41 There is a risk where it is unclear whether the lawyer-director was giving advice as a lawyer or as a director that both LawPro and the D&O insurer will deny coverage.42 (5) Adopt clear law firm and corporate policies and procedures As the Allen Case demonstrates, law firms and corporations should review their policies and protocols regarding the role of the law firm partner as both a board member and legal counsel to a corporation. Clear distinctions should be made regarding when one is acting as a director versus a lawyer. For instance, the firm could require the lawyer-director to refrain from giving legal advice during his or her tenure as director. In other words, legal advice and services could be provided to corporate clients solely by lawyers of the firm who are not acting at such time as a director of the client. The firm could also request written confirmation from the client

37 Francis, supra note 6 at 22; Bell and Gosnell, supra note 29 at 8. 38 [1994] O.J. No. 2. rev’d [1995] O.J. No. 2923 (Ont. C.A.). 39 Bell and Gosnell, supra note 29 at 17. 40 D’Silva, O’Kelly and Snow, supra note 16. 41 Ibid. 42 Ibid.

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that the lawyer-director is serving as director in his or her personal capacity and is not acting on behalf of the firm in any legal capacity in respect of the corporation.43 It would also be prudent to have the lawyer-director confirm in writing that they are serving as director in their individual capacity and not as a representative of the firm.44 Law firms may also want to review the scope and policy limits of the professional liability insurance available to the firm in different circumstances, including those described in the Allen Case. Regardless of whether the Allen Case decision survives the appeal, law firms and corporations should exercise care and adopt clear practices and policies in respect of their partners acting as directors of client corporations.

43 Ibid. 44 Ibid.

McMillan LLP  Brookfield Place, 181 Bay Street, Suite 4400, Toronto, Ontario, Canada M5J 2T3 Lawyers  Avocats  Calgary  Toronto  Montréal  t 416.865.7000  f 416.865.7048  mcmillan.ca

SCOPE OF RESEARCH — SOURCES CONSULTED Canadian Case Law Allen v. AspenGroup Resources Corp., (2009) CarswellOnt 7260. Kerr v. Lawyers’ Professional Indemnity Co., [1994] O.J. No. 2. rev’d [1995] O.J. No. 2923 (Ont. C.A.). Peoples Department Store Inc (Trustee of) v. Wise, [2004] 3 S.C.R. 461, 244 D.L.R. (4th) 564, 4 C.B.R. (5th) 215. Solosky v. The Queen, [1980] 1 S.C.R. 821. YBM Magnex International Inc. (Re) (2003), 26 OSCB 5285. Secondary Sources Patrick W. Straub, “ABA Task Force Misses the Mark: Attorneys Should Not be Discouraged from Serving on Their Corporate Client’s Board of Directors” (2000) 25 Del. J. Corp. L. 261. Micalyn S. Harris and Karen L. Valihura “Outside Counsel as Director: The Pros and Potential Pitfalls of Dual Service” (1998) 53 Bus. Law 479. Alan L.W. D’Silva, Partick O’Kelly and Ellen M. Snow, “Lawyers on Boards: Assessing the Risks and Limiting the Liability” LAWPRO Magazine 6:2 (Summer 2007). Catherine Francis, “The Lawyer as Director: Benefits and Pitfalls” (Ontario Bar Association Continuing Legal Education, 30 November 2004). Karen K.H. Bell and Duncan D. Gosnell, “The Lawyer as Director: Mercenary or Cannon Fodder” (Canadian Bar Association Continuing Legal Education, 7 May 1999).

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