Bank Wins Conspiracy Case

    The Court of Appeal of Alberta

In HSBC Bank Canada v. Fuss the Court of Appeal of Alberta upheld a conspiracy judgment against corporate directors.  The defendants had stripped a company of its assets and diverted its business to a new company they controlled in order to prevent the secured creditor from recovering on a loan.

Factual Background

Electronics Wholesale had an operating line of credit with HSBC Bank of Canada.  The line was secured by a General Security Agreement ("GSA") which provided that any money collected by the borrower was subject to a trust in favour of HSBC.

Cameron Kendrick was the sole director and shareholder of Electronics Wholesale.  David Fuss was a director of Ariza Technology Inc. and of Incredible Electronics Inc., two companies that were suppliers to Electronics Wholesale.  He was also director of a third corporation that became a 50% shareholder in Electronics Wholesale.  His wife, Rhonda Thuna, was then made a director of Electronics Wholesale.  She was also a director of Ariza and the company that owned half the shares in Electronics Wholesale.

Electronics Wholesale began to encounter business difficulties in 2003, but it still had sufficient assets and income to meet its obligations to HSBC.  Kendrick, Fuss, and Thuna created companies to take over the business of Electronics Wholesale.  One of their new companies was called Electronics Wholesale (Edmonton) Ltd. ("EWE").  They opened an account at the TD Bank in the EWE name, and all three were signing officers for that account.  All of the receivables coming to Electronics Wholesale, as well as the proceeds of the sale of that company's inventory, were deposited in the TD account.  They also incorporated a numbered company, which eventually took over the business operations of Electronics Wholesale, including its inventory, receivables, and staff.

In June of 2004 HSBC appointed a receiver and manager for Electronics Wholesale.  The company was petitioned into bankruptcy a month later, but the remaining assets were of little value and HSBC was unable to realize on its security.  In addition, Kendrick produced misleading financial information for Electronics Wholesale and destroyed the company's electronic records.

The Judgment at Trial

HSBC sued Kendrick, Fuss, Thuna, and the companies they controlled for conspiracy to prevent HSBC from recovering the debt owed by Electronics Wholesale.  The trial judge found that there was a conspiracy against the Bank and awarded damages of $1.7 million.  Fuss and Thuna appealed.  In a decision released June 25, 2013 the Court of Appeal of Alberta upheld the trial judgment.

The Decision on Appeal

The Memorandum of Judgment of the Court of Appeal contains a useful summary of the elements of the tort of "unlawful conduct" conspiracy, and a careful analysis of the factual and legal conclusions of the trial judge.

The only legal question in the case was the test for conspiracy by unlawful conduct.  Although the standard for appellate review on this issue is correctness, the parties agreed that the trial judge had stated the test correctly.

The appellants' critique of the trial judgment involved issues of mixed fact and law, as well as inferences that the trial judge had drawn from the facts.  On appeal, the findings of the trial judge on these kinds of issues are entitled to deference and will not be overturned unless the appellants can show "palpable and overriding error".

The elements of unlawful conduct conspiracy are:

(1)  An agreement to act in concert;

(2)  Unlawful conduct in furtherance of the agreement;

(3)  The unlawful conduct must be directed towards the plaintiff;

(4)  Knowledge that the conduct is likely to injure the plaintiff; and

(5)  The conspirators' conduct must actually cause injury to the plaintiff.

Agreement

The alleged conspirators must act in combination, or with a common design.  They must know the facts of the agreement and intend to participate in it.  Where direct evidence of the agreement is not available, the court can resort to circumstantial evidence.

Fuss and Thuna argued that in order to be participants in the conspiracy, they would have had to know about Kendrick's misstatements to HSBC and his destruction of corporate records.  The trial judge had found that they were not aware of these fraudulent activities.

The appellate court said that this argument misconceived the findings of the trial judge.  The agreement which supported the conspiracy finding was not based on fraud; it was based on a common design to divert the assets and business of Electronics Wholesale to the new companies.  Fuss and Kendrick had agreed to repay debt owed to Ariza in preference to payments due to the Bank.  Although Thuna was less active in the conspiracy, she knew that Electronics Wholesale was in trouble and that its business was transferred to EWE.  Her participation in the common design consisted in carrying out her husband's instructions while knowing that the effect would be to deprive HSBC of its security.

Unlawful Conduct

Unlawful conduct means actions that are legally wrong, but the conduct does not have to be actionable.  Highly competitive commercial activity that is not otherwise illegal does not qualify.

The trial judge found that Fuss and Thuna had breached their statutory fiduciary duties as directors.  As a director of Electronics Warehouse, Thuna had a duty to see to it that the company met its obligations to the bank.  The transfer of the company's assets with no legitimate business purpose and for inadequate consideration was against the interests of Electronics Warehouse, and also a breach of her duty to see to it that the company could meet its obligations.  The judge also said that Fuss breached his duty as a fiduciary of the numbered company by authorizing it to take over the assets of Electronics Warehouse, effectively appropriating trust property.

These conclusions on the fiduciary responsibilities of directors seem to imply that a director is obliged to ensure that the company carries on business in a responsible and ethical manner, and not just in a manner that promotes the company's business goals.  The Court of Appeal did not feel it was necessary to consider this interesting idea.  The assets of Electronics Warehouse were transferred, with the approval of the appellants, at less than fair market value.  This constituted a conversion of the property of Electronics Warehouse, which was unlawful conduct sufficient to meet this branch of the test for conspiracy.

Other Elements of the Conspiracy

The appellate court had little difficulty supporting the conclusions of the trial judge with respect to the remaining branches of the test for conspiracy.  The diversion of the receivables and other assets of Electronics Warehouse was a deliberate scheme to separate the assets of the business from the liabilities.  The appellants knew that their actions would prevent the Bank from recovering on its security, and HSBC suffered a substantial loss as a result.

Damages

The principal amount of the debt was about $670,000.  The trial judge added in interest, collection costs, insurance premiums, the receiver's charges, and legal fees as all of these amounts were to be added to the debt under the terms of the GSA.  This brought the total to $1.7 million.  The Court of Appeal supported this calculation of damages.

Conspiracy requires illegality, either as the goal of the conspiracy itself or in the means for carrying it out.  Hard-headed business tactics that do not involve illegality are not actionable.  Business people who have been harmed by corporate machinations often struggle to find the requisite "unlawful conduct" they require in order to succeed in an action for conspiracy.  If the Court of Appeal had upheld the views of the trial judge regarding the statutory duties of directors, it would expand the scope of the tort of conspiracy considerably; a ruling in the other direction would limit the scope of the tort.  As the Court of Appeal did not find it necessary to deal with the question, it will have to be resolved in another case on a different set of facts.

HSBC Bank Canada v. Fuss, 2013 ABCA 235, http://www.albertacourts.ab.ca/jdb_new/public/ca/2003-NewTemplate/ca/Civil/2013/2013abca0235.pdf

Contact Richard Hayles at Billington Barristers:

(403) 930-4106

RHayles@BillingtonBarristers.com

Visit our website: http://billingtonbarristers.com/index.php?id=59

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Any legal information provided is general in nature and may not apply to particular situations. It does not constitute legal opinion or advice. Please consult your lawyer regarding your specific legal issue.

Court Finds Fiduciary Relationship in Oil Sands Equipment Marketing Agreement

    Oil Sands Operations

Indutech Canada Limited manufactures pipe and other speciality steel products for Alberta's heavy oil industry.  Guy and Barry Gibbs marketed Indutech products for many years under two "Agency Agreements" which appointed the Gibbs and their companies as Indutech's exclusive sales force.  From 2000 to 2004 the Gibbs operated a competing manufacturing business, Cladtech Canada Limited, without Indutech's knowledge.

Indutech eventually learned about the operations of Cladtech and sued for breach of contract and breach of fiduciary duty.  The trial judge found in favour of Indutech, holding that the defendants were fiduciaries of Indutech and granting judgment for $2 million.  This award consisted of some $1 million in damages, including $150,000 in punitive damages, plus $1 million representing the profits that the defendants had made from competing with the plaintiff.

The defendants appealed from the finding that they were fiduciaries of Indutech, and from the damages awarded, particularly the order under which they were required to disgorge the profits earned from their enterprise in addition to compensatory and punitive damages.  In a recent decision, the Alberta Court of Appeal upheld the conclusions of the trial judge on both fiduciary duty and the amount of the award.

The reasons of the Court of Appeal provide a useful explication of the law respecting fiduciary relationships, both under the three part test established by the Supreme Court of Canada in Frame v. Smith, [1987] 2 S.C.R. 99 and International Corona Resources Ltd. v. LAC Minerals, [1989] 2 S.C.R. 574,  and under the more recently developed "ad hoc" analysis from Elder Advocates of Alberta Society v. Alberta, [2011] 2 S.C.R. 261 (S.C.C.).

The case is also interesting for the use of the remedy of "disgorgement".  The trial judge held that the plaintiff was entitled to be paid any profits that the defendants earned as a result of their breach of fiduciary duty, in addition to the traditional compensatory damages available for breach of contract.  The Court of Appeal agreed.

Fiduciary Relationships - The Principled Approach

A fiduciary relationship is one involving trust, obligations of confidentiality, and a duty to act in the interests of or for the benefit of another.  A finding of fiduciary duty allows the court to protect the vulnerable when they have been taken advantage of by those in positions of trust.  Courts enforce fiduciary duties because honesty, fairness, and protecting the weak from the strong are important values in our legal system.

The concept of fiduciary duty can be at odds with values of individual autonomy and self-reliance that are also important in our system of law.  This conflict between competing values manifests itself in a reluctance on the part of our courts to impose fiduciary obligations in a commercial context.  The role of the fiduciary can seem out of place in the business world; it often appears to be inconsistent with the notion of freedom of contract and the emphasis that the common law places on free markets and the enforcement of bargains.

Historically, fiduciary obligations arose in certain established categories of relationships, such as agent and principal, solicitor and client, or trustee and beneficiary.  Since it is well understood that an agent has to protect confidential information, avoid conflicts of interest, and act for the benefit of the principal, anyone who agrees to act as an agent also agrees, either expressly or by implication, to take on the responsibilities of a fiduciary.

More recently, courts have recognized that the categories of fiduciary relationships are not closed.  It now appears that the categories that historically gave rise to fiduciary responsibilities are only instances in which a set of principles have been applied to identify fiduciary relationships.  This principled approach to fiduciary relationships, which originates in the dissenting opinion of Wilson, J. in Frame v. Smith, was endorsed by the Supreme Court of Canada in Corona Resources.  Under the Frame v. Smith analysis, relationships in which fiduciary obligations are imposed possess three characteristics: 

1. The fiduciary is in a position to exercise discretion or power over the affairs of the beneficiary;
2. The fiduciary can exercise that power unilaterally, so as to effect the beneficiary's interests;
3. The beneficiary has a particular vulnerability to the fiduciary.

The defendants in Indutech argued that they were not agents as the agreements gave them no authority to bind Indutech.  Since the substance of the relationship prevails over the words used by the parties to describe it, the fact that the two contracts between Indutech and the defendants were labelled "Agency" agreements was not determinative.  This meant that the courts had to struggle with the issue of whether or not to find a fiduciary relationship between two business organizations dealing with each other at arm's length.

The Court of Appeal concluded that the terms of the agreements did give the defendants power and discretion, which resulted in a corresponding vulnerability on the part of Indutech.  The agreements made the defendants the exclusive sales force for Indutech.  The defendants were required to keep Indutech informed about the market and about sales opportunities.  The defendants were subject to a duty of loyalty and were restricted from dealing with Indutech's competitors.  They had unlimited access to Indutech's customers and sales data, including confidential information on pricing, timing, and market strategy.

Indutech gave the defendants confidential business information, treating the defendants' personnel as if they were Indutech employees.  This close relationship made Indutech vulnerable as it provided the defendants with the opportunity to divert sales, manipulate prices, and influence purchasing decisions by providing Indutech customers with false scheduling information.  Vulnerability by itself does not give rise to fiduciary duties, but where it arises out of the contractual relationship between the parties rather than from pre-existing causes outside the contract, a fiduciary relationship can be formed.

There is a line of authority supporting the proposition that the courts should hesitate to find a fiduciary relationship when two corporations motivated by profit enter into an arm's length transaction.  The court was at pains to distinguish these cases, stating that the principle is limited to a situation in which a business entity fails to take available steps to protect its interests, then turns around and complains that it was taken advantage of.  In the instant case, Indutech built protections into the terms of the agreements, but the defendants gained advantage through a series of calculated breaches of those contractual protections.

The Court of Appeal emphasized the fact that in the commercial context a fiduciary relationship has to be based on the terms of the contract and not on circumstances external to the contract.  As in the traditional categories of fiduciary relationships, the principled analysis requires an "undertaking" on the part of the fiduciary to take on duties of trust and confidence.  The court concluded that "Such a circumstance arises where, as here, the contract imposed express obligations of loyalty and non-competition."

The "ad hoc" Analysis of Fiduciary Obligation

The Court of Appeal also considered the applicability of the approach established in the Elder Advocates decision, in which a fiduciary relationship is founded on an "ad hoc" basis outside traditional categories.  The requirements for an ad hoc finding of fiduciary relationship were summarized by McLachlin, J. in Elder Advocates:

1. Vulnerability arising from the relationship, as in Frame v. Smith;
2. An undertaking by the fiduciary to act in the best interests of the beneficiary;
3. A defined person or class that is subject to the fiduciary's control; and
4. The fiduciary can adversely exercise discretion or control so as to affect the beneficiary's legal or practical interests.

The Court of Appeal decided to uphold the trial judge's decision as the facts that supported the existence of a fiduciary relationship under a Frame v. Smith analysis also supported an ad hoc finding of fiduciary obligation.  On the facts of the Indutech v. Gibbs case, the two approaches to the issue are very similar, and the Court of Appeal suggested that they may just be "different ways of stating the same thing".

The common thread that runs through the cases on fiduciary relationships is the vulnerability of the beneficiary and the "undertaking" or agreement of the putative fiduciary to do something that is associated with a fiduciary role.  Whether the approach is one of traditional categories of fiduciary relationship, the principled analysis from Frame v. Smith, or the ad hoc approach from Elder Advocates, the fiduciary has to agree to keep information in confidence, refrain from competition, safeguard another's property, give precedence to the beneficiary's interests, or otherwise undertake an obligation of loyalty and trust.  If the beneficiary is vulnerable to a breach of the undertaking, a fiduciary relationship is established.

Compensatory Damages and the Disgorgement Remedy

The normal measure of damages for breach of contract is an amount that would restore the income that the plaintiff lost as a result of the breach.  These are sometimes referred to as "compensatory" damages.  Where the defendant is in breach of a fiduciary obligation, the court can go further; in addition to awarding compensatory damages, it can order the defendant to disgorge any profits arising from the breach of duty.

The defendants had diverted sales and opportunities rightly belonging to Indutech in a number of different instances.  The fact that the defendants were in breach of their fiduciary obligations did not justify an across the board application of the disgorgement remedy.  Indutech had to establish, in each instance, that the defendants' profits result from breach of fiduciary duty and not merely from breach of contract.

As the trial judge had been careful to distinguish between activities that constituted breach of contract and those that amounted to breach of fiduciary duty, and limited the award to compensatory damages where no breach of fiduciary duty was involved, the Court of Appeal upheld her use of the disgorgement remedy.  The remedies for breach of fiduciary duty are discretionary, so the standard on appellate review is reasonableness.  Since the trial judge had not committed any error of law in applying the disgorgement remedy, the Court of Appeal was not prepared to interfere with the exercise of her discretion.

Punitive Damages

In cases involving breach of fiduciary duty, the court can award punitive damages in addition to compensatory damages; the purpose of the punitive damages is to deter the defendant and others from engaging in similar conduct, and to uphold the integrity of fiduciary relationships.  In the Indutech case, the Court of Appeal stated that if a market is to operate smoothly and effectively, manufacturers have to be able to rely on their sales representatives to protect confidential information and trade secrets.

Punitive damages have to be proportionate.  In determining whether or not to award punitive damages, the court is to consider such factors as the harm caused, the degree of misconduct, the relative vulnerability of the plaintiff, and the advantage and profit accruing to the defendants.  The defendants argued that the addition of the disgorgement remedy amounted to sufficient deterrence, and that an award of exemplary damages was therefore disproportionate.

The Court of Appeal concluded that the trial judge had exercised her discretion reasonably.  The $150,000 punitive damages award was proportionate to the balance of the award ($1.85 million), and amounted to appropriate deterrence in light of the long period of deliberate and flagrant breaches of contract and the dishonesty and deceit involved.

Indutech Canada Limited v Gibbs Pipe Distributors Ltd., 2013 ABCA 111

http://www.albertacourts.ab.ca/jdb_new/public/ca/2003-NewTemplate/ca/Civil/2013/2013abca0111cor1.pdf

Contact Richard Hayles at Billington Barristers:

(403) 930-4106

RHayles@BillingtonBarristers.com

Visit our website: http://billingtonbarristers.com/index.php?id=59

Any legal information provided is general in nature and may not apply to particular situations. It does not constitute legal opinion or advice. Please consult your lawyer regarding your specific legal issue.