Northern Exposure

Can Corporate Officers’ Duty of Loyalty Limit Their Right to Compete?

The Court of Appeal of Quebec recently overturned a decision of the Superior Court ordering former directors and officers to pay their ex-employer $3,185,148. The damages had been awarded for appropriating a business opportunity of the former employer and for having breached their obligations of loyalty and good faith under the Civil Code of Quebec. It was a business opportunity on which the employees had actively worked in the course of their employment with Enerchem Transport inc. (ETI).

The appeal court in Gravino v. Enerchem Transport Inc. confirms that, absent specific noncompete and nonsolicitation agreements, ex-directors or officers may, in certain circumstances, fulfill the duty of loyalty owed to their former company while still pursuing for themselves certain business projects that were started while engaged with the prior company.

The Supreme Court of Canada recently dismissed ETI’s application for leave to appeal.

Facts
ETI is a provider of marine transportation services. Having learned that a certain oil company had excess shipping capacity, three of its officers started negotiations to have ETI subcharter certain tankers from that oil company. Two of these officers were also directors and shareholders of ETI.

The two shareholders in question exercised their put-call options under ETI’s shareholder agreement and terminated their employment with it. The governing noncompete agreement ceased to apply. These ex-officers then formed a new business, (Petro-Nav), competing directly with ETI. They then successfully negotiated for Petro-Nav to subcharter the same tankers ETI had sought.

Having been bested by Petro-Nav, ETI instituted legal proceedings against its two ex-officers, contending that they had breached their duties toward ETI.

The two ex-officers responded that they had the right to compete with their previous employer according to the terms of the shareholders agreement. They alleged that they acted according to the rules of freedom of trade and competition, a fundamental rule of any organization of commercial activities. They also alleged that the obligation of the loyalty in the Civil Code of Quebec can be amended by contract, as in the shareholder agreement in this case.

Quebec Court of Appeal decision
The duty of loyalty of corporate officers. The Court of Appeal confirmed that the ex-officers could compete against their former employer since the noncompete clause ceased to apply at the termination of their employment. This was true as long as the general rules of the Civil Code of Québec are respected. Certain rules in the Civil Code are mandatory, such as the duty of loyalty of a corporate officer or director. One can’t contract out of these mandatory rules.

The court indicates that the following principles apply in Quebec with respect to fiduciary duty and appropriation of a business opportunity:

  1. The level of fiduciary duty varies according to the responsibilities – the higher the responsibilities, the higher the level of the duty.
  2. The fiduciary duty relies on loyalty, good faith, and the absence of conflict of interest.
  3. The fiduciary duty prohibits a director or a senior officer from appropriating, secretly and without the consent of the company, a commercial advantage of the company especially if the director or officer participated in the negotiations.
  4. The business opportunity must be in the process of realization.
  5. The company shall be protected only if it actively pursues the business opportunity.
  6. The prohibition to appropriate a business opportunity survives after the officer has left the company for a certain period according to the circumstances.
  7. The survival of the prohibition arises either by a resignation caused by the wish to obtain the opportunity or if the business opportunity doesn’t result from a new initiative of the director or senior officer but from his position within the company.
  8. Return of profits is an appropriate remedy.
  9. The injured company doesn’t have to prove that it would have been successful in realizing the business opportunity.
  10. The company doesn’t have to prove that confidential information was used.
  11. The offers presented by the director or senior officer to obtain the business opportunity don’t have to be substantially similar.

The maturing business opportunity. Appropriation of a business opportunity isn’t specifically mentioned in the Civil Code of Quebec. However, the court concluded that it was incorporated in the Code’s prohibition, which bars a director from using any information he obtains by reason of his duties for his own benefit or that of another party unless he is authorized to do so.

In the court’s view, apart from a situation where property had been misappropriated or clientele diverted, a business opportunity had to have acquired a level of specificity sufficient to be almost autonomous in order to be covered by the prohibition in the Civil Code.

In this case, the court concluded that the negotiations between ETI and the third parties involved had been too preliminary to serve as a basis for finding that a real business opportunity had existed or been misappropriated.

Conclusions
The Quebec Court of Appeal has confirmed that the duty of loyalty survives the resignation of directors or officers. The resulting prohibition against appropriating a business opportunity also survives the departure. But the period of time during which the prohibition continues to apply will vary, depending on the circumstances of each case.

However, the court does point out that this prohibition is not a substitute for a negotiated noncompetition clause. In the absence of any conflict of interest, borrowing what was merely a business idea would be without consequence. This decision also reaffirms the importance of employers protecting their interests by negotiating enforceable post-departure restrictions, not only for senior management but also of corporate officers.

Contact the author, Dominique Launay