"The Bright Line vs. The Bottom Line", Harper Grey LLP Law Bulletin

2005

By Kimberly J. Jakeman and Julie K. Gibson

Overview

In an important development since our articles titled "The Bright Line"1 and "Crossing the Line"2, the British Columbia Court of Appeal rendered judgment in 3464920 Canada Inc. v. Strother ("Strother")3 holding a corporate solicitor liable for damages that are potentially in excess of $32 million. The solicitor was found to have breached the "duty of loyalty" as articulated by the Supreme Court of Canada in R. v. Neil ("Neil")4.

The Court made it clear that, although Neil was decided in the criminal litigation realm, the duties of loyalty and confidentiality that apply to litigators apply equally to corporate solicitors:

The foregoing passage from Ramrakha v. Zinner was quoted with approval by the Supreme Court of Canada recently in R. v. Neil [2002] 3 S.C.R. 631. Binnie J. for the Court also made the point that confidential information may or may not play a role in the broad principle that a lawyer must avoid conflicts of interest. (See para. 17.) The duty of loyalty was said to encompass a duty of commitment to the client's cause - i.e., to ensure that a divided loyalty does not cause the lawyer to "'soft pedal' his or her defence of a client out of concern for another client" - and a duty of candour with the client on "matters relevant to the retainer". (para. 19) In my opinion, these duties are as applicable to solicitors who provide commercial or tax advice in connection with their clients' business affairs as they are to barristers who represent their clients in courts of law.5

Although this paper focuses on the Strother decision, other recent cases have also clarified the extent of the "bright line" duty. For example, in Jorgensen v. San Jose Mines Ltd. ("Jorgensen")6, the Court grappled with the conflicts that arise where a lawyer jointly represents what are essentially two separate clients who have the potential to become adverse in interest. In Uniform Custom Countertops Inc. v. Royal Designer Tops Inc. ("Custom")7, the Ontario Superior Court of Justice held that the fact that a law firm serves a client of another firm by acting as agent does not insulate the agent firm from the duty of loyalty owing to the client. GMP Securities Ltd. v. Stikeman Elliott LLP ("GMP")8 is a decision where the same Ontario Court held that the duty of loyalty can extend not only to the law firm's client, but to the clients of the client. The "bright line" of Neil has even found its way across our border into the United States where it was referred to in a lawsuit brought by entertainer Michael Bolton, against his previous law firm, for a conflicts issue related to a joint retainer.9

Courts are consistently reminding lawyers that the professional and ethical obligations to the client ought to supplant any interest that might conflict with that of the client. The integrity of our profession requires that we remain loyal and steadfast to our clients' interests.

The Strother Decision

The facts in Strother engage the recurrent issue of the involvement of lawyers in business enterprises. A corporate solicitor and then partner ("Strother") of the national law firm Davis & Company ("Davis") was retained to provide advice to a client ("Monarch") regarding tax assisted production services financing ("TAPSF") which was a film industry related tax shelter of considerable financial benefit for Monarch at the time.

In late 1996, new "Matchable Expenditure Rules" under the Income Tax Act were introduced by the Minister of Finance. These new rules appeared to end the availability of TAPSF syndications in Canada. The rules came into effect on November 1, 1997. Legal advisors across Canada told their clients that the tax shelter business in this regard was over. Strother advised Monarch that he had no "technical fix" and, acting on this advice, Monarch closed down their TAPSF business after October 31, 1997.

While this was going on, Strother took on a former principal of Monarch as a new client ("Darc"). Darc and Strother jointly developed a revised structure that would circumvent the negative implications of the new Matchable Expenditure Rules such that TAPSF syndications could potentially be restarted. The retainer agreement provided that Strother would make a percentage of the profit and Davis would be retained to prepare the necessary offering memorandum if a positive ruling from Revenue Canada was obtained. Strother would also be entitled to a voting interest in the corporate entities - the Sentinel Hill Group ("Sentinel"). Strother did not advise Monarch that he had taken Darc on as a client.

In late 1997, Monarch again sought Strother's advice about what could be done in respect of the inability to promote tax shelters. Strother made no indication that there was something that could be done, despite the fact that he had already spoken to a representative of the Canada Customs and Revenue Agency and learned that an advantageous tax ruling may be possible in respect of the new structure developed by him and Darc. On examination for discovery, Strother acknowledged that he was aware of the interest of Monarch that any possibility of staying in business needed to be presented to it.

Through Strother and Darc's effort, the new corporate entity of Sentinel obtained an advantageous TAPSF ruling from Revenue Canada on October 6, 1998. Strother left Davis officially on March 31, 1999 to join Sentinel.

According to an expert report filed at trial by Monarch, the Sentinel Hill Group raised approximately $40 million through TAPSF syndications in 1998 and a further $600 million in 1999. Strother's share in profit from the business was estimated to be $32 million.

The Court of Appeal held that Strother was in a conflict of interest in two senses - a conflict between Monarch and Darc (Sentinel Hill); and a conflict between his own interests and those of Monarch.

What is a Retainer?

The Court had to grapple with the definition and extent of retainer agreements. It held that a written retainer between a lawyer and a client does not end the lawyer's duty of loyalty and/or the lawyer's fiduciary duty to the client.

At trial, the Court had held that because the retainer between Davis and Monarch, which contained an exclusivity/fee agreement had ended, Strother was no longer under any obligation to keep Monarch advised of the possibility that TAPSF syndications could be revived, or at a minimum that his earlier advice might be incorrect on that point. The Court of Appeal disagreed, and held that the duties owed to the client survive the end of the written retainer:

But although the term of the exclusivity/fee agreement had expired, the solicitor client relationship between Monarch and Davis did continue, without the negotiation of a new written agreement. The relationship now took the form more usual between corporate clients and law firms: Monarch consulted as necessary on various matters from time to time and Mr. Strother provided advice, or seconded other lawyers to do so according to their expertise, and billed on the basis of the firm's usual hourly rates. … Thus when the trial judge stated at para. 106 that the "retainer" was not renewed in 1998, he must be taken to be referring to the written agreement of October 8, 1996 and not to the solicitor client relationship between Davis and Monarch.10

Continuing on the issue of whether the solicitor client relationship was maintained despite the expiry of the formal written retainer between Strother and Monarch, the Court stated:

One must not, however, equate the scope of a lawyer's contractual duty to advise his client usually a matter of fact like that at issue in Smith v. McInnis with his fiduciary duties, including the duty not to place himself in a position of conflict and the duty to disclose any personal interest he may have that might affect his loyalty and dedication to the client's cause… Certainly when Monarch asked ‘what was to be done', it was entitled to an honest and complete answer, whether or not Mr. Strother had a file open for continuing TAPSF work. … In my opinion, it does not lie in his mouth to say now, as Mr. Macintosh contends, that Messrs. Knutson and Cheikes "were not consulting Mr. Strother on tax shelters and they had no expectation of receiving any advice in that regard." They were not legally knowledgeable, and whether they "expected" to be told that there was a possible solution to their predicament, they were entitled to candid and complete advice from a lawyer who was not in a position of conflict.11

Strother's fiduciary duty required him to give advice beyond what his firm's written retainer required. In this regard, the Court referred to the decision in Clark Boyce, where the judicial committee stated:

That a solicitor owes a fiduciary duty to a client is not in doubt. The classic case where the duty arises is where a solicitor acts for a client in a matter in which he has a personal interest. In such case there is an obligation on the solicitor to disclose his interest and, if he fails so to do, the transaction, however favourable it may be to the client, may be set aside at his instance. … Another case of breach is where a solicitor acts for both parties to a transaction without disclosing this to one of them or where having disclosed it he fails, unbeknown to one party, to disclose to that party, material facts relative to the other party of which he is aware. A fiduciary duty concerns disclosure of material facts in a situation where the fiduciary has either a personal interest in the matter to which the facts are material or acts for another party who has such an interest. It cannot be prayed in aid to enlarge the scope of contractual duties.12

The survival of this fiduciary duty is nothing new. In the 1908 decision of Allison v. Clayhills, Parker J. held that "…a solicitor's fiduciary duty will last as long as his "ascendancy" over the client can operate and thus may require full and proper disclosure of his interest in any transaction between himself and his client "long after the relationship of solicitor and client in the stricter sense had ceased to exist.""13 This may seem onerous for the solicitor, and in fact in some circumstances costly, but in reality it is nothing more than what is expected of lawyers everyday in practice.

Lawyers and clients will want to ensure they consider the extent of the retainer carefully and will be mindful not to construe it too narrowly. The solicitor-client relationship may very well extend beyond what was initially contemplated.

When Conflicts And Confidentiality Collide

The Court held that, given that the confidential information about the new scheme belonged at least partly to Darc, Strother was not in a position to disclose it to Monarch. However, "having undertaken to work towards a tax ruling that would contradict the continuing advice he had given and was continuing to give Monarch either by his silence or by telling its principals there was ‘nothing to be done' Strother had placed himself in an untenable position of conflict of duty and of interest."14

The Defendants argued that the confidentiality of client information could excuse the failure to advise Monarch of the conflict of interest. The Court rejected this submission, and referred to Neil where Binnie J., writing for the Court, emphasized that confidential information may or may not play a role in the lawyer's duty to avoid conflicts of interest.15

Once the Court of Appeal construed the retainer to include an ongoing solicitor/client relationship, although arguably these were unrelated files, it was really no surprise that the Court logically held that Strother should have told Darc that he could not accept his business in the first place and that his failure to do so meant that he could not be candid with Monarch, the existing client. The Court also indicated that, once Strother accepted Darc's retainer and became entitled to a share of the profits under the new scheme, he was required to cease acting for both clients and to alert Monarch to the possibility that his previous advice was incorrect.

The Court was not asked to decide whether Strother was then also precluded from going into business with Darc, but the Honourable Madame Justice Newbury suggested that, even if he had first left his law practice, he was ""the only person of all mankind" who could not take up the opportunity at least without the fully informed consent of Monarch."16

The Duties & The Decision

In Neil, the duty of loyalty was defined as the duty of avoiding conflicting interests, the duty of committing to the client's cause and the duty of being candid with the client on matters relevant to the retainer. Strother breached the threefold duty to Monarch crossing the "bright line".

The trial judge was of the view which I do not doubt as a general proposition that solicitors may routinely act, and must be free to act, for clients who are competitors. (Para. 115.) But in my respectful opinion, that proposition is not determinative in this case. Not only were Monarch and Sentinel Hill "commercial competitors"; Monarch was relying for advice from a lawyer who was entitled to 50 per cent of the profits and equity shares of Sentinel Hill. Unbeknownst to Monarch, Mr. Strother himself was "the competition". He had both a direct personal interest, and an indirect professional interest, in seeing that Monarch remained in the dark and that Sentinel Hill was first to market with the new structure. Even assuming the confidentiality of the "new idea", this was a breach of the duty of loyalty he and his firm owed Monarch. To paraphrase the elements of that duty as described in Neil, his duty to avoid conflicting interests, his duty of commitment to the client's cause, and his duty of candour with the client on matters relevant to the retainer were all compromised. The "bright line" was crossed.17

The Court discussed fiduciary duties in the context of conflict situations, stating that:

…It is hardly necessary to state that this context is not governed by the law of the marketplace or of contract or negligence alone, but by the principles of "trust, confidence, and independence": per La Forest J. in Hodgkinson v. Simms [1994] 3 S.C.R. 377, at 415.18

A lawyer must take care to ensure that he maintains the confidence and trust of his client and importantly, fulfills his obligation to remain loyal to his client.

Could the Client be Liable?

Clients may run a risk of having liability imposed on them in situations where their lawyer breaches the duty of loyalty to other clients while the new client is enjoying the profits arising out of the lawyer's breach.

Although Monarch made claims against its former employee Darc, the claims were dismissed at trial and upheld on Appeal. Darc was restricted at all times from appropriating any confidential information belonging to Monarch, either for his own use or for the use of a Monarch competitor, but the Court of Appeal held that the trial Judge had not erred in concluding that the idea used by Darc with respect to a financing structure that would circumvent the consequences of the new tax rules was actually invented by Darc and not inappropriately taken from Monarch.

Monarch also argued that Darc participated in Strother's breach of fiduciary duty and should be liable on that basis. The Court of Appeal was not prepared to find on the evidence that Darc knew that Strother was in breach of his fiduciary duty as a lawyer, or that Darc was reckless or wilfully blind to it.

An attempt was made to analogize Darc's situation to that of a stranger to a trust who might be held liable on the basis of "knowing receipt", as explained in the Supreme Court of Canada decision of Citadel General Assurance Co. v. Lloyds Bank Canada [1997] 3 S.C.R. 805:

…relief will be granted where a stranger to the trust, having received trust property for his or her own benefit and having knowledge of facts which would put a reasonable person on inquiry, actually fails to inquire as to the possible misapplication of trust property. It is this lack of inquiry that renders the recipient's enrichment unjust.19

The Court was not presented with any case law on the question of participation by strangers in other types of breaches by fiduciaries such as Strother. However, the Court concluded:

In my view, it would have been reasonable for him [Darc] to think, had he considered it, that the amounts he received were attributable to his own perseverance and skill, in combination with the skill of Mr. Strother, and to his ownership of shares in the enterprise rather than to a breach of duty by Mr. Strother.20

Darc was able to extricate himself from liability but every client should be aware of this potential and consider carefully the solicitor-client relationship.

Liability Of The Law Firm

The Strother decision does not determine whether Davis, where Strother was a partner at the time of his breach of duty, is liable, either directly or vicariously, for his breach. The Court has asked for additional submissions and a decision on this point is likely in the near future. We expect another compelling analysis from our Court of Appeal determining Davis' liability not too far in the distant future.

What Does the Future Hold?

Strother and other recent decisions make it abundantly clear that the "bright line" duty of loyalty is integral to the justice system in Canada and has broad implications for lawyers, law firms, clients and former clients. Excuses for failing to meet the duty of loyalty are not readily accepted by the Courts. As Adams J. expresses it:

This may from time to time present harsh and unpleasant choices to lawyers when considering whether to accept a retainer. Nevertheless, the integrity of our system of justice dictates that there be no erosion in the high confidence placed in the legal profession by members of the public. The assurance of complete and unequivocal loyalty and confidentiality of the lawyer to the client is one of the cornerstones of a system of justice which has evolved to be the envy of much of the world.21

What can be distilled from Strother is that the threefold duty of loyalty to the client trumps any personal interest by a lawyer in another client's business. A conflict such as that exhibited in Strother is best avoided by refusing the business of a second client where accepting such a retainer would make it impossible to be candid with an existing client. Beyond this, there is the obligation to remain committed to the client's cause, and to keep an ongoing client advised on matters relevant to the retainer, despite an end to a written retainer.

Endnotes

1. Kimberly J. Jakeman and Shanti M. Davies, The Bright Line: The Decision of R v. Neil and its Impact on the Business of law in Canada, The Advocate (2003).
2. Kimberly J. Jakeman, Bryan G. Baynham, Q.C., and Praveen K. Sandhu, Crossing the Line: Courts apply Neil while The Law Society of B.C. considers an exception, Harper Grey Webpage (2003).
3. 3464920 Canada Inc. v. Strother, 2005 BCCA 35.
4. R v. Neil [2002] S.C.J. No 72 (SCC).
5. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 7.
6. Jorgensen v. San Jose Mines Ltd., 2004 BCCA 400.
7. Uniform Custom Countertops Inc. v. Royal Designer Tops Inc. [2004] O.J. No. 3090 (Ont. Sup. Ct. Jus.).
8. GMP Securities Ltd. v. Stikeman Elliott LLP [2004] O.J. No 3276 (Ont. Sup. Ct. Jus).
9. M. Moxley, “A question of loyalty” The National Post (October 2004). This article notes that a United States lawsuit brought by Michael Bolton against his former law firm engages conflict of interest issues arising out of the joint representation of Michael Bolton, his music publishing company and his record label . The case thus far is unresolved, but has resulted in counsel being ordered to attend depositions regarding confidential communications. See Bolton v. Weil Gotshal, Supreme Court of New York 602341/03.
10. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 13.
11. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 17.
12. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 22 citing Clark Boyce v. Mouat [1993] 4 All E.R. 268.
13. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 24 citing Allison v. Clayhills (1908) 97 L.T. 709, [1904-7] All E.R. Rep 500 (Ch.D.).
14. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 25.
15. R v. Neil, supra at Note 4.
16. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 25 quoting in part from Keech v. Sandford [1726] Sel. Cas. Ch. 61, 25 E.R. 223.
17. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 29.
18. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 21.
19. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 78 citing Citadel General Assurance Co. v. Lloyds Bank Canada [1997] 3 S.C.R. 805 paragraphs 48 & 49.
20. 3464920 Canada Inc. v. Strother, supra at Note 3 paragraph 81.
21. Dobbin v. Acrohelipro Global Services Inc, 2004 NLSCTD 178 at paragraph 42.