Going Commando: Special Circumstances and Solicitors Act Assessments

“Somewhere, somehow, someone’s going to pay.” (Commando)

“History is written by the victors.” - (Winston Churchill)

Corporate warfare may be bloodless, but it is no less ruthless; and sometimes, it is the litigators who end up as collateral damage, at least as far as their paid accounts are concerned.
The recent decision of the Court of Appeal for Ontario in Echo Energy Canada Inc. v. Lenczner Slaght Royce Smith Griffin LLP, 2010 ONCA 709 ["Echo Energy"] further clarifies the meaning of “special circumstances” under s. 11 of the Solicitors Act, R.S.O. 1990 c. S.15 and reinforces a “client-centred approach” for determining whether solicitors’ accounts that have already been paid may be referred for assessment.

The appellant, Echo Energy Canada Inc. and five of its directors retained the respondent Lenczner Slaght Royce Smith Griffin LLP in relation to certain litigation. The appellant retained Voorheis & Co. LLP on Lenczner’s recommendation to assist with some aspects of the litigation. Once some of the litigation was completed and another group took control of the appellant, the appellant sought to assess the Lenczners and Voorheis accounts. Both firms’ accounts totaled almost $840,000, and since they had all been approved by the former group’s President Gary Conn and paid, the appellant had to establish special circumstances.
Concurrently,  the appellant sought to refer the paid accounts of McCarthy Tétrault LLP for assessment. McCarthys had been retained by the former control group as the appellant’s corporate lawyers  arising from a conflict of interest with the appellant’s former law firm. McCarthys accounts of $144,000 represented its work over a one year period. All but one of these accounts were paid prior to the change in control.
The application judge, Brown J., found there were no special circumstances with respect to any of the accounts and declined to direct the references.In a split decision, (Goudge, J.A. dissenting) Rosenberg, J.A. (Feldman J.A. concurring) allowed the appeal in relation to Lenczners and Voorheis, but dismissed the appeal with respect to McCarthys.
Echo Energy Canada Inc. ["Echo"] is a natural gas operator in Ontario.  In 2007, one of the directors and a substantial shareholder, Salvatore Fuda, surmised that public disclosure of the appellant’s gas reserves was inaccurate.  In November 2007, Echo received a request from Fuda’s company, Challenge Gas Holding AB to appoint an independent consulting engineer to review the appellant’s gas reserves and to appoint an additional director.  When no response was forthcoming, Fuda called a meeting of the appellant’s Board of Directors during which time his proposals were rejected.  At this same meeting, the Board authorized a private placement of shares that potentially would dilute the Fuda group’s shareholder stake.  The next day, the Fuda group called a special shareholders’ meeting for the purpose of voting two of its nominees onto the Board. 
The intra-corporate battle ultimately came before Morawetz J., who dismissed the application for a declaration that the acquisition by Challenge of the appellant’s shares was in violation of the Securities Act, R.S.O. 1990, c. S.5. The net result was a change in control of the Board and installation of new management led by the Fuda group.  The appellant thereafter commenced litigation against some of its former officers and directors for breach of fiduciary duty based upon an independent reserves engineering firm report that found significant declines in the appellant’s gas reserves, causing it to take a write-down on its gas reserves from $44M to $11.8M.
The application judge, Brown, J. dismissed the application to refer all of the accounts for assessment., rejecting the argument that the firms should have known that the five directors were not acting in the best interest of the company as without merit. Rosenberg, J.A. rejected the “lawyer-centred” approach taken by the application judge:
[33]          In my view, the motions judge erred in principle in several respects.  He looked at the case from the perspective of the lawyers rather than the client.  He failed to take into consideration evidence rebutting the presumption that the client accepted the account as proper and reasonable.  And, he relied on a speculative theory that lawyers would not undertake this kind of work if they knew their accounts might be assessed when new management came in.

[36]          In my view, the starting point was not the perspective of the lawyers.  Section 11 of the Solicitors Act attempts to strike a balance between a solicitor’s legitimate interest in finality and the client’s interest in access to an independent process for review of accounts for legal services.  However, the starting point ought to be the perspective of the client.  

[37]          The application judge’s error in taking a law firm focused approach led him to conclude that the manner in which the accounts were approved did not constitute special circumstances.  By taking this approach, he failed to consider the evidence showing that the appellant was not well served by those within the company tasked with making the decisions about the conduct of the litigation, including payment of the accounts.

[40]          Furthermore, the reasons of Morawetz J. disclose troubling conduct and motives of Mr. Conn and Mr. Moore.  Mr. Conn and Mr. Moore were members of the special committee that was supposed to be overseeing the litigation and Mr. Conn approved the lawyers’ accounts for payment.  Morawetz J. found that many of the witnesses on both sides of litigation were not credible in important respects.  But, he made a finding against Mr. Conn that raises the spectre that he may not have been acting in the best interests of the corporation.  Morawetz J. was troubled that the issue of the propriety of the Challenge share transaction was raised for the first time three years after the fact, when the result could be that Mr. Conn and the other directors would be ousted from the company.

The learned justice concludes:

[42]          In my view, these findings, coupled with the apparent failure of the special committee to fulfill its function in supervising the litigation in a transparent way, go a long way towards establishing special circumstances.  Those facts tend to rebut the presumption that the appellant accepted the accounts as proper and reasonable.  It cannot be forgotten that it was the appellant, a public company, that was paying the bills, not the directors.

 …

[45]          There are other factors that, in my view, point towards this being a case of special circumstances.  I would summarize them as follows:

·        The Lenczners written retainer referred only to action brought by Challenge, not to any of the other litigation;
·        The written retainer is signed by Mr. Conn on behalf of the appellant, there is no written retainer on behalf of the five directors;
·        There was no written retainer with Voorheis;
·        The appellant had total revenue of $2.8 million in 2008, recorded expenses of over $5 million, yet spent almost $840,000 on litigation during that period;

·        The relatively short time that elapsed before the application was brought.

[46]          Taking into consideration all of these factors, the appellant made out a case of special circumstances with respect to the accounts from Lenczners and Voorheis.
Conversely, McCarthys’ accounts were not subject to “special circumstances”:

[50]          I take a different view of the application to assess McCarthys’ accounts.  The appellant has pointed to no circumstances that would rebut the presumption of propriety and reasonableness arising from the payment of the accounts.  The findings by Morawetz J. and the lack of transparency within the special committee do not affect the accounts rendered by McCarthys in its role as corporate counsel and de facto secretary to the Board.  The appellant adduced no evidence to show that the amounts billed were excessive.  The appellant paid McCarthys’ last account, without complaint, after the change in management.  The suggestion that there may have been some duplication of work with the litigation counsel is not supported by anything in the record.  While McCarthys too did not produce its retainer until after the application was launched, Mr. Fuda was part of the process retaining McCarthys.

Interestingly, Goudge, J.A.in his dissent takes a more pragmatic (if not arguably, Machiavellian) view of the Conn and Moore’s motives and actions in the best interests of the corporation, when he wryly observes:

[66]          … it is important to underline that the presumption that the appellant must rebut is that when it paid the accounts, that is presumed to reflect its acceptance of the reasonableness of those accounts. It is the appellant’s acceptance at the time of payment that matters. There is no doubt that, at that time, the appellant considered it in its best interest to resist the attempted at takeover by the Fuda group by vigorously defending the litigation brought by that group and by commencing the proceeding before Morawetz J.  The Conn directors, including Mr. Conn, shared the same interest. I do not think anything said by Morawetz J. can be taken to suggest that Mr. Conn and Mr. Moore may not have had the company’s best interest in mind when the accounts were approved.  They shared that interest.

The Court of Appeal’s client-centred approach is laudable. It is the cornerstone of ethical lawyering.  I agree that lawyers are professionally bound to put their clients’ interests before their own. My only question is: how many other professions permit a client to obtain a refund after having reviewed and then paid an account? I am inclined to side with Justice Goudge that there may be a chilling effect if highly sophisticated business clients are able to assess accounts simply as a result of a change in control. In my view, litigators can no longer “go commando” with boiler-plate retainer agreements. Litigators must now seriously consider including change of control clauses in retainer agreements to protect against retaliatory assessments, or include arbitration clauses to balance the scales. The only alternative it seems, is to have an extra pair of underwear handy.

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