THE CANADIAN EMPLOYEE COMPETITION BLOG

Genesis Fertility Centre Inc. v. Yuzpe, 2019 BCSC 233

A decision of the British Columbia Supreme Court rejects a claim for disgorgement of profits, even though the Defendants committed breaches of fiduciary duty and confidence. The decision is a reminder that, in employee competition cases, the courts will be mindful of whether departing employees’ profits arise from their own skill and effort as opposed to any breaches of duty. Further, the courts will not allow equitable doctrines to be used to award remedies out of proportion to wrongdoing.

A departed employee’s success in attracting former clientele to a new place of business frequently gives rise to disgorgement claims by the aggrieved former employer. Asserting a breach of fiduciary duty or breach of confidence, the plaintiff seeks an accounting (or “disgorgement”) of the defendant’s profits, in addition to the claim for damages, reserving the right to claim the more favourable remedy at trial.

The prospect of the court ordering disgorgement, which may far exceed the plaintiff’s damages, provides the plaintiff a ready incentive to allege causes of actions for which that remedy is available.  A recent decision from the British Columbia Supreme Court, however, underscores the limits of the disgorgement remedy in employee competition cases. Even if the asserted breach is established, the courts may not be inclined to strip away all of a defendant’s profits, given the departed employee’s right to compete.^[1]

In Genesis Fertility Centre Inc. v. Yuzpe, 2019 BCSC 233, the Court addressed the conduct of several specialist physicians who had sold their shares in a fertility clinic to one physician who remained. The departing physicians worked out a 60-day notice period, during which time they took preparatory steps to establish a competing clinic, Olive, which would open immediately upon the expiry of the notice period.

At trial, the departing physicians were found to have committed several breaches of fiduciary duty and breach of confidence, including:

• Entering into employment agreements with several Genesis employees while the physicians continued to be directors of Genesis;
• Utilizing confidential information of Genesis to prepare their business plan and hire Genesis employees; and
• Failing to keep Genesis updated, while still shareholders, as to their activities in preparing to establish a competing fertility clinic.

The primary remedy sought by the Plaintiffs was payment by the departing physicians of the $4.275 million paid by the remaining physician for their shares, on the ground that, immediately upon the remaining physician being obliged to pay this sum, the Defendants set about to “destroy that very business that they had just sold…”.

The Court rejected this characterization, finding their object instead was to continue to practice medicine together in their area of practice. The Court also found there had been no breach of the shareholders’ agreement, which had set out the procedure for the sale of shares.

The Plaintiffs sought the alternative remedy of disgorgement of the Defendants’ profits for a two-year period, on the basis that the shareholders’ agreement contained a confidentiality covenant of that duration.

The Court found the Plaintiffs’ argument ignored the contractual right of the departing physicians to compete with Genesis. Importantly, the Court also distinguished between several cases cited by the Plaintiffs, where the “central act” involved an objective that itself was a breach of fiduciary duty, and the object of the departing physicians, which was to continue to practice medicine together in their area of practice:

[285]     Determining an appropriate remedy in this case presents challenges that were not present in many of the cases relied upon by the plaintiffs. Most of those cases involved a central act that was a breach of fiduciary duty. In such cases less serious breaches of duty can be viewed as being done pursuant to an object that was itself a breach.

[286]     In Canadian Aero Service, the pursuit of the contract was held to be wrongful. In Strother, the wrong was pursuing a business opportunity that put Mr. Strother in a conflict of interest position with his client. In Cadbury Schweppes Inc., the wrong proven was utilizing the plaintiff’s confidential formula to manufacture a competing product. In Hodgkinson v. Simms, 1994 CanLII 70 (SCC), [1994] 3 S.C.R. 377, the wrong was failing to disclose a conflict of interest. In each of these cases, the defendants would not have obtained a benefit but for their breach of duty.

[287]     In this case, however, I have found that the Departing Physicians had the right to set up a competing clinic within which to practise and that the benefit they obtained came from that lawful activity. I must be careful not to deprive them of that benefit in any remedy I grant.

Accordingly, the Defendant physicians might only be required to disgorge any benefits received from their breach of duty. They were not required to disgorge profits arising from lawful activity on their part. Relying on a decision from the Australian High Court, Warman International v. Dwyer, the Court further stated:

[315]     The law is clear that a fiduciary who has breached a duty must account only for what it acquired in consequence of the breach. The overarching consideration is summarized in Warman International Ltd. v. Dwyer, (1995) 128 A.L.R. 201 (H.C.A.) at 214:

In determining the proper basis for an account of profits, it is of first importance in this, as in other cases, to ascertain precisely what it was that was acquired in consequence of the fiduciary’s breach of duty. And, in some situation, it may also be relevant to ascertain what was lost by the plaintiff….

The Court noted this passage was cited with approval by the Supreme Court of Canada in Strother v. 3464920 Canada Inc., 2007 SCC 24 (CanLII). Justice Binnie in that decision held there must be a causal connection between a breach of fiduciary duty and the benefits obtained by the wrongdoer before an accounting can be ordered. Paraphrasing Strother, the Court in Genesis stated that  “equitable doctrines should not be used to impose awards out of proportion to the fiduciary’s behaviour…”.

In rejecting the Plaintiffs’ claim for disgorgement, the Court in Genesis concluded:

[331]     …I find that substantially all of the benefits the Departing Shareholders earned from Olive were acquired from their skill, effort and professional standing in the medical profession.

[332]     The Departing Physicians had well established practices and reputations before they formed Olive. I am satisfied that it was their professional standing and the excess of demand for the services they were able to provide over the supply of such services in the community that accounted for the incomes they earned through Olive.

…

[335]     The remedy sought by Genesis would deprive the Departing Physicians of all of their earnings for a two-year period. In my view, such an award would be out of proportion to any benefits obtained by the defendants from their breaches of fiduciary duty and breaches of confidentiality. The stringent rule requiring a fiduciary to account for profits should not be carried to extremes and should not be transformed into a vehicle for the unjust enrichment of the plaintiff.

Having dismissed the Plaintiffs’ claim for disgorgement of two-years of earnings, the Court instead assessed the Plaintiffs’ damages at $187,000.

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The need to establish a causal link between a breach of fiduciary duty or breach of confidence and a departed employee’s profit must be kept front and centre when considering whether a substantial disgorgement remedy is realistic. As was the case in Genesis, the courts are sensitive to the right of departing employees to compete and that their own skills, reputation and effort may be the cause of customers following them, not any unlawful activity.

There will be cases where the courts will look beyond causation and strip away substantial profits even when doing so amounts to a windfall to the plaintiff. That was the case in Strother, where the Supreme Court of Canada noted that disgorgement can be directed to either a prophylactic or a restitutionary purpose. Citing the prophylactic purpose of deterring the faithless fiduciary, the Court stripped away 15 months’ of profits realized by a lawyer arising from breach of fiduciary duty to his client, without applying any reduction to recognize the lawyer’s own skill and effort in generating those profits.

In many other cases – and Genesis appears to be one of them – the underlying breach does not engage the same policy considerations. In such cases, the courts will determine the appropriateness of the disgorgement remedy keeping in mind the right of departing employees to compete and whether their own skill and effort generated a profit rather than the breach.

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[1] Of course, the right to compete may be circumscribed in limited circumstances by an enforceable non-competition covenant, but the remedy for breach of such a covenant consists of the plaintiff’s damages, not the defendant’s profits.