Strother v. 3464920 Canada Inc.: A Conflict of Interest

Strother v 3464920 Canada Inc., 2007 SCC 24 [Strother], is an important decision which clarifies the obligations of law firms to their clients, as well as former clients. This appeal from the British Columbia Court of Appeal was released by the Supreme Court of Canada (“SCC”) on Friday, June 1, 2007 and has generated discussion in newspapers, among the legal profession, as well as right here at the The Court.

Monarch Entertainment Corporation, the plaintiff, ran a tax shelter investments program in the 1990s for Canadian taxpayers by allowing them to supply American studios which produce films in Canada with services by purchasing units in a limited partnership. Monarch hired Davis & Company (“Davis”), a large Vancouver law firm, and used the services of tax lawyer Robert Strother pursuant to a written retainer signed in 1996 that expressly prohibited the firm from acting for other clients with related tax-shelter programs. Near the end of 1996, the Income Tax Act, RSC 1985, c 1 (5th Supp), was amended to eliminate tax shelter schemes. Strother advised Monarch that he had no solution to neutralize the effects of the new amendment. Within a year, Monarch eliminated the tax shelter portion of its business and laid off several employees, including Paul Darc, a defendant.

At the end of 1997, the written retainer was terminated. Monarch, however, continued to be a client of the firm and in 1998, Davis and Strother were verbally retained by Monarch to investigate other business opportunities related to tax assistance.

At the end of 1997 or early 1998, Darc approached Strother with a new idea by which to avoid the legislative amendments attempting to eliminate Tax‑Assisted Production Services Funding (“TAPSF”) investments. They agreed to submit a proposal to Revenue Canada which, if successful, would result in Strother receiving 55 percent of the first two million dollars of profit and 50 percent thereafter to the new company, Sentinel Hill. Strother did not advise Monarch of this new possibility for the film production services business, nor of the favourable ruling that was issued by Revenue Canada in October of 1998.

In August of 1998, Strother wrote a memorandum to Davis’ managing committee about a possible conflict of interest regarding his simultaneous work for Monarch and Darc/Sentinel. In it he said that Sentinel’s prospects were uncertain and he advised, incorrectly, that he had only “an option to acquire up to 50% of the common shares of Sentinel Hill”. The managing partner of the firm responded and informed Strother that he was forbidden from owning any interest in Sentinel. On March 31, 1999, Strother resigned from Davis & Company to work at Sentinel as a 50 percent shareholder. Throughout 1998 and 1999, Monarch continued to use the law firm for general unrelated corporate work, as well as various outstanding film production services transaction matters. After learning about Sentinel’s 1998 tax ruling from sources outside the firm, Monarch sued both Strother and Davis & Company for breach of fiduciary duty and breach of confidence, but never returned to the film production services business.

In 2003, at trial, the judge found no wrongdoing and dismissed Monarch’s action. In 2005, the Court of Appeal ordered Strother to surrender all benefits and profits he received, or will receive, from Sentinel, later estimated to be around the $32 million dollar mark. The Court of Appeal also ordered that Davis & Company yield the profits stemming from legal fees for work done for Sentinel in breach of its duty to Monarch and return all fees paid by Monarch from January 1, 1998.

While the SCC split 5-4, the majority explained that once the exclusivity arrangement with Monarch expired, Strother and the firm were permitted to take on both Darc and Sentinel as new clients, providing that they were “candid about their legal advice while protecting from disclosure the confidential details of the other client’s business”. However, pursuant to the 1998 verbal retainer, Strother came in conflict with his fiduciary duty to Monarch by taking a personal financial interest in Sentinel. This compromised his duty to “zealously” represent Monarch’s interest. The SCC found that Strother should be required to pay Monarch any profit earned from Sentinel between January 1, 1998 and March 31, 1999, the date at which the conflict was extinguished as both Strother and Monarch had dissolved their relations with the firm. He was also ordered to pay Monarch any profit obtained from hours docketed to Monarch’s account, or fees paid to the firm by Monarch, during the time when Strother was in a position of conflict. On the other hand, Davis was not found to have breached any fiduciary duty to Monarch, but was vicariously liable for Strother’s actions under s. 12 of the British Columbia Partnership Act, RSBC 1996, c 348.

As expressed by Justice Binnie in paragraph 34 of the judgment:

“When a lawyer is retained by a client, the scope of the retainer is governed by contract. It is for the parties to determine how many, or how few, services the lawyer is to perform, and other contractual terms of the engagement. The solicitor-client relationship thus created is however overlaid with certain fiduciary responsibilities, which are imposed as a matter of law…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.”

Even with a well drafted retainer, fiduciary duties, which include the duty of loyalty and the avoidance of conflicts of interest, still exist and can extend beyond the retainer. Furthermore, the decision imposes liability on an innocent firm for the transgressions of its partners. With the trend toward law firms increasing in size, but decreasing in numbers, firms, especially those that operate nationally, must be careful to pay attention to organization and diligently examine their partners’ activities to ensure that they do not find themselves mistakenly in situations involving a conflict of interest.