SCC split on fiduciary duty of lawyer

A Vancouver lawyer still has to pay a former client damages for breach of fiduciary duty following a widely-anticipated ruling on conflicts of interest that divided the Supreme Court of Canada, but cleared up unanswered questions for the profession.

Strother v. 3464920 Canada Inc. involves tax lawyer Robert Strother, a former partner at Davis LLP who was sued by a former client for breach of fiduciary duty and breach of confidence after he became involved in a tax shelter business that was considered the client’s competitor.

In a 5-4 decision, the Supreme Court majority sided largely with the B.C. Court of Appeal, ruling that, in 1998, Strother put himself in a position of conflict between his duty to the client, Monarch Entertainment Corporation (now known as 3464920 Canada Inc.) and his personal financial interest, and that he failed to provide Monarch with the legal advice to which it was entitled that year.

According to court documents, Strother was retained in the mid 1990s to advise Monarch on its tax shelter investments. While Strother’s retainer with the company was over at the end of 1997, Monarch remained one of Davis’ clients. However, in late 1996, the federal government announced its intention to amend the Income Tax Act to defeat certain tax shelters, and Strother advised Monarch that he could not avoid the effects of the new rules.

In late 1997 or early 1998, former Monarch executive Paul Darc approached Strother to discuss a potential tax shelter/tax credit business. While reportedly skeptical, according to the judgment, Strother drafted a proposal that was submitted to Revenue Canada in March 1998.

Strother and Darc agreed that Strother would receive a percentage of the profit of the new company, called Sentinel Hill Entertainment Corp., if the tax ruling was granted and 50 per cent thereafter. Revenue Canada in October 1998 issued Sentinel a favourable tax ruling, however, Strother did not advise Monarch about the ruling.

Throughout 1998 and early 1999, the law firm continued to do some work for Monarch on outstanding matters. After Strother wrote a memo to Davis’ management committee about a possible conflict of interest with respect to acting simultaneously for Monarch and Darc or Sentinel in 1998, the firm’s managing partner told Strother that he would not be permitted to own any interest in Sentinel.

Strother resigned in March 1999 from Davis and became a shareholder in Sentinel the following month. After learning of Sentinel’s tax ruling, Monarch sued Strother and the firm for breach of fiduciary duty and breach of confidence.

The trial judge dismissed the claim, but the Court of Appeal allowed the appeal and ordered Strother to disgorge to Monarch all benefits and profits received from Sentinel. It also ordered that the law firm disgorge the profits it earned in legal fees from acting for Sentinel in breach of its duty to Monarch from Jan. 1, 1998 and return Monarch all fees it paid from that date. Strother and Davis appealed, and Monarch cross-appealed the dismissal of its claims against Darc and Sentinel.

Justice Ian Binnie, writing for the majority, emphasized the scope of fiduciary duty and the extent of the retainer after 1997.
“Fiduciary duties provide a framework within which the lawyer performs the work and may include obligations that go beyond what the parties expressly bargained for. Fiduciary responsibilities include the duty of loyalty, of which an element is the avoidance of conflicts of interest,” wrote Binnie.

“Monarch’s tax business was in a jam. Strother was still its tax lawyer. There was a continuing ‘relationship of trust and confidence.’ Monarch was dealing with professional advisors, not used car salesmen or pawnbrokers whom the public may expect to operate on the basis of ‘didn’t ask, didn’t tell,’ and who collectively suffer a corresponding deficit in trust and confidence. Therein lies one of the differences between a profession and some businesses.”

Although it ruled against Strother on the conflict-of-interest front, the Supreme Court allowed his appeal in part, with respect to the remedy. It reduced the time Strother must account to Monarch for the personal profit gained directly from Sentinel and indirectly through his earnings from Davis to just over a year. This may ultimately reduce the amount he must pay Monarch to nearly $1 million from $32 million, according to Strother. The court must still determine the amount of Strother’s profit and make a money judgment against him.

Both the minority and majority also agreed Davis committed no breach of fiduciary duty to Monarch and is not liable for Strother’s breaches of fiduciary duty, except under the terms of s. 12 of the Partnership Act. Davis’ liability is limited to vicarious liability for the amount determined by the court.

In its dissenting reasons, the minority would have dismissed all claims against Strother and Davis, agreeing with the trial judge’s findings that Strother’s duty to Monarch did not extend beyond the terms of the retainer agreement, and that he did not breach his contractual or fiduciary duty to Monarch.

Chief Justice Beverley McLachlin wrote, “In my view, whether a conflict between two clients exists is dependent on the scope of the retainer between the lawyer and the client in question. The fiduciary duties owed by the lawyer are molded by this retainer, as they must be in a world where lawyers represent more than one client.

“Our law rightly imposes rigorous fiduciary duties on lawyers, but it also recognizes the need to ensure that fiduciary obligations remain realistic and meaningful in the face of the realities of modern practice,” she wrote.
Gavin MacKenzie, a partner at Heenan Blaikie LLP and legal ethics guru, says the majority and the minority in the case agreed on fundamental guiding principles, which will help the legal profession by answering questions that were left unanswered after the decision in the 2002 conflicts case, R. v. Neil.

In Neil, which emphasized the duty of loyalty, the guiding principle expressed by the court was that a lawyer or law firm must not act directly adverse to the immediate interests of a current client of the firm, he says. There has been surprisingly little jurisprudence since Neil to determine in what circumstances a firm would be found to have acted adversely to the interests of a current client.

“We now know, certainly at a minimum, based on the Supreme Court of Canada’s decision in Strother, that firms are expected to be free to act, or may act for commercial competitors even in a fairly narrow market and that the fact that they’re acting and giving advice to one competitor in a market isn’t going to be treated as being directly adverse to the other client’s immediate interests,” says MacKenzie.

“I think if there’s one moral to be taken away from the case . . . it has to do with the importance of providing, specifically in retainer agreements, just what it is the law firm is being retained to do and any limitations on the services that the law firm is agreeing to provide.”

Parker MacCarthy, president of the Canadian Bar Association, which intervened in the case, says the CBA argued that the application of the rule in Neil has to take into account each individual case.
“We were seeking to avoid the risk of unnecessary expansion of the duty, that could really be an adverse impact on the proper functioning of the legal system,” he says.

The CBA also addressed broader issues, such as nature and duration of the retainer giving rise to the duty of loyalty, nature of the client’s interests, and nature of the adversity of interests between two clients, whether legal or commercial.

The decision will provide comfort to lawyers in some areas, says MacKenzie, notably business lawyers, as the court found that when a law firm develops an agreement or product for the benefit of a client, such a product belongs to the lawyer or law firm, not the client.

Whether this is the third decision in a trilogy relating to conflicts of interest in the legal profession, following 1990’s MacDonald Estate v. Martin and Neil, or just part of a continuum, MacCarthy says the Canadian bar has recognized this as an issue of tremendous concern to lawyers and clients. As a result, the CBA has recently set up a task force on conflicts in law firms to develop practical guidelines for the profession in applying the duty of loyalty and implementing appropriate modifications of the duty.

“We see this as an important issue in all of the different settings for the practice of law, whether it’s a lawyer in an isolated small centre, right up to the multinational firms,” he says.

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