Mar 16, 2015

A resigning fiduciary is not forever blocked from setting up a competing business

Gravino c. Enerchem Transport inc., 2008 QCCA 1820 (CanLII)

FACTS

In the business world of marine transport, Ultramar negotiated with Enerchem Transport Inc. (ETI) for the latter to sub-charter three Rigel tankers to Ultramar, so that ETI could benefit from Ultramar’s excess transport capacity. Gravino & Carson were then actively involved shareholders and directors of ETI and though no agreement was reached, they took part in the negotiations. Two years later, G & C exercised their put-call options under ETI's unanimous shareholder agreement, liquidating their interest, and subsequently terminated their employment. After they left ETI, they formed a new business - Petro-Nav and began negotiations to have Petro-Nav sub-charter the same tankers. Within a year, Petro-Nav succeeded in sub-chartering the tankers.

ETI instituted legal proceedings against its two ex-officers, C & G, contending that they had breached their duties toward ETI. ETI alleged that its former directors and officers (C & G) had staked out this business opportunity and on behalf of ETI when it was their employer and competing with the interests of that former employer, they breached their duty of loyalty.

JUDICIAL HISTORY

The Superior Court held that there was duty of loyalty owed to ETI and ordered C & G, as former directors, to pay ETI $3, 185, 148. The trial judge held that appropriating a business opportunity of the former employer and for having breached their obligations of loyalty and good faith under the CCQ (arts. 322 & 323). C & G appealed to the QCCA arguing their right to compete with their previous employer according to the terms of the shareholders agreement (SA). They invoked rules of freedom of trade and competition, adding that an obligation of the loyalty as per CCQ can be amended by contract (the shareholder agreement in this case).

ISSUES

I.Can former directors and officers be freed from their non-compete obligation through the application of a mechanism in the shareholder agreement and thus compete with their former employer?

II. A. Can duty of loyalty be done away with by contract much like the duty not to compete? B. What is the obligation to act loyally and in good faith in the context of a maturing business opportunity?

HELD

I.Yes but only within the bounds of their remaining obligations towards the latter (the competition must be approached loyally).

II.A. No, duty of loyalty and honesty is general law and cannot be contracted out of. B. Art. 323 CCQ provides the legal basis of the prohibition against a director or officer appropriating for their benefit a maturing business opportunity.

REASONING

I.The non-compete clause in the shareholder agreement

QCCA upheld the trial judge's findings re the application of the non-competition clause between ETI and its ex-officers, affirming that the lifting of such a clause operates to allow free competition as long as the general rules of the Civil Code of Québec are respected. Those that are supplementary in nature can be overridden by contract, but rules that are of mandatory application, such as the duty of loyalty of a corporate officer or director, cannot. Basing itself on the principles canvassed in Marque d’Or Inc. v. Clayman, QCCA confirmed that the contractual extinction of a non-compete clause does not free a debtor from the public-order obligation to act loyally and in good faith (general law). Thus, the former directors and officers in this case were freed from their non-compete obligation through the application of the mechanism provided in the shareholder agreement and could therefore compete with their former employer, but only within the bounds of their remaining obligations towards the latter.

II.The obligation to act loyally and in good faith

The QCCA confirmed in part the trial judge's findings on the question of the duty to act with honesty and loyally: to determine the scope of the duty to act with honesty and loyalty, it was necessary to consider the applicable provisions of the CCQ along with the principles laid down by the SCC in Canadian Aero Service Ltd. v. O'Malley(and cases that had followed in its wake). QCCA held that the duty of loyalty owed to ETI by its ex-officers in this case was all the greater given the high level of responsibility of the positions they had held with the company. Appropriation of a business opportunity not being specifically mentioned in the CCQ, QCCA held that Article 323 CCQ provides the legal basis of the prohibition against a director or officer appropriating for their benefit a maturing business opportunity.

What is a maturing business opportunity?

This flexible, rather ambiguous concept but it is basically a business opportunity on its way to becoming a transaction: any opportunity may be up for grabs but the more an opportunity matures within a scope of negotiations, the more it becomes appropriated to particular parties privy to the impending transaction. QCCA noted that the concept of a "maturing business opportunity" as such was not found in the CCQ. However, it was incorporated in the prohibition, found in article 323 CCQ that bars a director from using for his own (or a third party’s) profit any information he obtains by reason of his duties, unless he is authorized to do so. However, this prohibition was not a substitute for a negotiated non-competition clause, and that in the absence of any conflict of interest, borrowing what was merely a business idea would be without consequence.

QCCA identified four main factors to be weighed in order to determine whether misappropriation of a maturing business opportunity had taken place:

i) degree to which the interests of the director and the interests of the company were in conflict,

ii) degree to which the business opportunity had, at the time in question, acquired its own specific and identifiable character,

iii) proximity in time between the emergence of the business opportunity and its exploitation and

iv) proximity in character between the business opportunity pursued by the company and the contract or business concluded by the director for his own profit or the profit of a third party.

Notwithstanding a situation where property had been misappropriated or clientele diverted, a “business opportunity had to have acquired a level of specificity or identifiability sufficient to be almost autonomous" in order to be a maturing business opportunity subject to the prohibition of article 323 CCQ

In the case at hand, the QCCA found that Petro-Nav or its principals did not usurp what was a maturing business opportunity for ETI due to the following factors:

·existence of the opportunity in question was generally known in business circles (as opposed to being confidential);

·the project was exploratory and hypothetical in nature (as opposed to being in an advanced state of completion;

·C & G had the knowledge of the business opportunity even before a new shareholder acquired its interest in ETI (as opposed to learning about it specifically by reason of their duties);

·there was absence of a continuing conflict of interest (the directors concerned having resigned from the board); and

·the opportunity that was ultimately exploited differed in its execution from the one that ETI had been pursuing.

QCCA stressed that in a market as marine transport, a vague commercial purpose (in this case, that of acquiring the ability to operate ships) did not amount to a maturing business opportunity. Even though the opportunity exploited by Petro-Nav was consistent with the general goals ETI had been pursuing, the negotiations that had taken place between ETI and the third parties involved were too preliminary to serve as a basis for finding that a real business opportunity had existed. In concluding its analysis, the Court noted that the criterion of elapsed time could not be dissociated from the analysis of a situation where a breach of the duty to act with honesty and loyalty was alleged.

RATIO

A contractual provision, even an explicit one, cannot override the duty of loyalty owed by a director or officer. The duty of loyalty survives the resignation of the director or office. The resulting prohibition against appropriating a business opportunity for ex-director’s own benefit also survives her/his departure from the company, but the period of time of the prohibition’s applicability will vary, contingent on the circumstances of each case.

In a free-market economy, freedom of competition is the basic rule. Duty of loyalty can be tempered by the degree of conflict of interest that existed, the degree of specificity of the project, the proximity in time and the degree of resemblance between the business opportunity being pursued and the one ultimately concluded. These criteria are the markers of the degree of maturation of a business opportunity. In sum, ex-directors or officers may, in certain circumstances, fulfill their duty of loyalty owed to their former company while still pursuing, for their own or others' benefit, business projects that were started by them while they held office with the company.