Today, the Supreme Court of Canada released a much-anticipated decision in Davis & Co. v. Monarch Entertainment Corporation. The case is of particular interest to lawyers practising in the field of commercial law because it has clarified the obligations owed by law firms to clients and former clients. The Court’s decision to impose liability on a law firm for the misdeeds of one of its partners, even though the firm itself was innocent, will cause law firms to scrutinize the activities of their partners more closely in the future.
Davis & Company is a large law firm with offices in various cities but based principally in Vancouver. In the 1990’s, Robert Strother was a partner at the firm. He represented Monarch Entertainment pursuant to a written retainer agreement. Monarch’s business involved the marketing of tax shelter investments targeted at the motion picture industry. These investments vehicles are referred to in the decision as “tax-assisted production services funding” or “TAPSF”.
The retainer agreement between Monarch and Davis generally prohibited the firm from acting for clients other than Monarch in relation to TAPSF schemes. This “exclusivity” arrangement expired in 1997. Nevertheless, the retainer was tremendously profitable for Davis, which received more than $5 million in legal fees from Monarch from 1993 to 1997, and for Strother, who was one of the firm’s biggest billers.
In 1996, the Minister of Finance announced that the Income Tax Act would be amended to do away with TAPSF tax shelters. Strother advised Monarch that he could not come up with any way of getting around the new legislative measures.
Within a year, Monarch had wound down its lucrative TAPSF business. It laid off a number of employees, including one named Paul Darc. Around the same time, Strother learned of a possible way to circumvent the government’s measures to end TAPSF investments. He was approached by former Monarch employee, Darc, about starting a tax credit business. Strother agreed to help Darc in seeking a favourable tax ruling from Revenue Canada. In return, he was to get 55 percent of the first $2 million of profit and 50 percent of any remaining profit.
At no time did Strother tell Monarch that there might, after all, be a way for it to continue in the film production services business.
Strother and Darc’s company, “Sentinel Hill”, sought and obtained a favourable advance tax ruling from Revenue Canada in late 1998. Strother told his partners at Davis, that he had an option to acquire an interest in Sentinel. In fact, he had already entered into an agreement to share in the profits of Sentinel. The managing partner of his firm told Strother that he (Strother) would not be permitted to own any interest in Sentinel.
During this time, Davis was continuing to do legal work for Monarch on various commercial matters. It was an important part of the Court’s ruling that, in 1998, Monarch had verbally retained Davis and Strother to explore other tax-assisted business opportunities. As Mr. Justice Binnie pointed out in the reasons for the majority in the Supreme Court, the only reason that Monarch was looking at alternative opportunities was that Strother had advised it that the TAPSF investments could no longer be pursued.
In 1999, Strother resigned from Davis and joined Darc as a 50 percent shareholder in Sentinel. The venture was very successful for a number of years, earning profits of about $130 million. Darc and Strother together had realized profits of more than $64 million and Davis, which had done legal work for Sentinel and related companies, had received fees of more than $9 million.
Monarch learned of Sentinel’s 1998 tax ruling in early 1999. It severed its relationship with Davis and threatened legal action against Strother and Darc. Monarch never did re-enter the film production services business though, which was an important fact for purposes of the Supreme Court’s decision.
Strother had argued that once the exclusivity arrangement with Monarch ended in 1997, he had no obligation to tell Monarch about a possible way around the legislated end of the TAPSF schemes. He took the position that his advice to Monarch in 1997, that he had no “fix” to the government measures targeting film production tax shelters, was honestly given and that he had no duty to correct it when he learned that other options might exist.
The majority in the Supreme Court (the Court split 5-4) agreed that generally, a lawyer does not owe a duty to correct past legal advice in light of changed circumstances. As Binnie J. put it, “a client cannot assume that the lawyer’s opinion has an indefinite shelf life”. But that did not avail Strother on the facts of this case, in the majority’s view, because Strother’s contractual liability arose not out of any obligation to correct his 1997 opinion to Monarch (that he had no “fix”), but out of his 1998 retainer, according to which he was advising Monarch on tax-assisted business opportunities more generally.
Justice Binnie said that if this were a contract case, he would have no hesitation in holding both Strother and Davis liable for breach of the 1998 retainer. But because Monarch never re-entered the tax-assisted film production services business, it had no damages. Accordingly, the Court considered the positions of the parties in the area of fiduciary duty. Here, Monarch asked that the Court order Strother, Darc, Sentinel and Davis to disgorge all of the money that they made between 1998 and 2001 in breach of fiduciary obligations owed to it.
Justice Binnie for the majority undertook a detailed analysis of the fiduciary obligations on lawyers and that discussion will not be summarized here. In a nutshell, the majority found that with proper disclosure, Strother and Davis could have taken on both Monarch and Sentinel as clients, although Strother could not have had a personal interest in either. So long as the law firm could fully discharge its duty to both clients without disclosing confidential information, it would have had no problem.
But here, Strother had breached his fiduciary duty to Monarch by placing himself in a position to derive a direct, personal benefit from information which he had a duty to share with Monarch, but did not. This compromised his ability to “zealously” represent Monarch, since, in effect, he personally was one of its competitors in a restricted market.
In the result, Strother was ordered to disgorge profits earned up to the time that he left Davis in March, 1999. The majority said that at that point, “the conflict was spent”. The Court acknowledged that the disgorgement would result in a “windfall” to Monarch, but defended the use of the remedy on the basis that it served a “prophylactic purpose”: teaching that conflicts of interest do not pay.
Davis was not found liable to Monarch for any breach of fiduciary duty, except for its vicarious liability under the B.C. Partnership Act, for the actions of Strother. So, on that account, liability was imposed. Justice Binnie said that he expected that Davis would then claim indemnity from Strother.
The law firm was not ordered to repay the fees that it had charged to Monarch for legal work in 1998 and 1999.