CEOs, be careful what you ask for
What can occur when a board of directors approves the contract for a senior officer to obtain unreasonable compensation?
Steven Berg was an American lawyer and businessman who introduced Repap Enterprises to Third Avenue Funds and became the largest shareholder in the Canadian company.
Berg’s proposed compensation was considered at two board of directors meetings. At the first, the board retained an independent compensation consultant to consider it. Following the second, two directors resigned, one of them the chairman of the compensation committee. The board of directors was reconstituted and approved the new compensation committee’s recommendation supporting Berg’s agreement. It provided generous payments, benefits and perquisites, including a five-year term with renewals, a 25- million- share signing bonus, 75 million shares in stock options, a market capitalization bonus, an eightyear pension credit, and liberal change of control and termination provisions. Berg became Repap’s chairman and senior executive officer.
In approving this agreement, the new board relied on an opinion prepared by Margaret Engel, a Mercer compensation consultant, who, due to time constraints on her opinion, was limited in scope and based it on “high-level observations.”
Engel mistakenly understood that she was providing advice in a non- contentious executive contract. She was not informed that Berg was unknown to the members of the board. Neither she nor the new board knew that his employment contract had met with resistance from the earlier board, that the chair of the compensation committee had resigned and that management was opposed to the agreement and questioned its propriety.
Within weeks, the new outside directors resigned and a new board was appointed. Berg was not nominated for re- election. His employment was terminated.
Repap asked the court to set aside Berg’s agreement.
The court’s description of Berg’s evidence is worth not- ing — in what not to do. As Justice Lax found, “I do not find Mr. Berg to be a credible witness. His evidence was tainted by self- interest. He was unresponsive to questions. In the face of important documents that were in clear contradiction of his testimony, he made no concessions.”
Berg had received materials from directors and board members indicating their discomfort with his proposal, but did not provide them to the new board.
Ontario Superior Court Justice Lax found that Berg had a fiduciary duty to act honestly, in good faith and in the best interests of his company, as well as to disclose the nature and extent of any personal interest contrary to the company’s. It is not enough, she found, for a senior officer and director to remind their colleagues of the interest in his own contract. They should know not merely that he has an interest, but what it is and how far it goes, and he must see to it that they are informed.
As well, every director or senior officer must place the interests of the corporation above their own. As Justice Lax found, “a reasonably prudent chairman and director acting in the best interests of Repap would have provided a new board with the opportunity to educate itself so as to make informed business judgment. As well, he should have afforded the board adequate time to retain a compensation consultant and instruct the consultant sufficiently to derive an genuinely independent opinion about his own employment contract.”
The court concluded, “Mr. Berg failed utterly in his duties to Repap. His own self-interest prevailed. His conduct was exactly opposite of the conduct the law required of him as a fiduciary — disclosure, honesty, loyalty, candour and a duty to favour Repap’s interest over his own.”
The Ontario Court of Appeal upheld the setting aside of Berg’s contract.
The law has moved considerably in dealing with fiduciaries. Even if they declare their self-interest, they still must act in the best interests of the company. Egregious compensation arrangements can be and are being set aside by the courts.