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

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 of 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 opportunity 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 of 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. 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

Page 2 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 Act 2 (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 ordinary 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 Act 3 . 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 ordinary 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.

Page 3 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 of 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.