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James C. Morton*

A recent decision from the British Columbia Court of Appeal (Strother [2005] BCJ No. 80) emphasizes how important it is to ensure that law firms keep a close track on what their partners are doing. Potential damages as much as $32,000,000 may be available against one of Western Canada’s oldest and largest legal firms because of actions by a former partner who acted in a conflict of interest to his client. It should be noted that these damages, if recovered, would likely be outside of insurance coverage.

Specifically, as a tax partner of the firm, the solicitor advised the client that changes in tax rules rendered the client’s film production tax shelter operation no longer viable. As a result, the client shut down its film production tax shelter business. The client continued to do work with the solicitor, however, the solicitor learned of a way around the changes in the tax rules that would allow a film production tax shelter business to operate and be profitable. The solicitor, together with a former employee of the client, set up a new business (which he kept secret from the client) operating in the film production tax shelter area.

The knowledge of the solicitor’s law firm with regard to the secret business was not particularly clear although it appears that the solicitor took some efforts to keep the full scope of his business interests secret from his law firm.

The conflict between the solicitor and the client is obvious. The Court had little difficulty disposing of arguments that the solicitor was not in conflict. The Court notes:

¶¶ 4 Both conflicts arose no later than January 30, 1998 when the lawyer prepared and entered into a written contract on his own account with the former employee of Monarch. In it, he agreed that his law firm would form certain new corporations and limited partnerships and provide the services necessary to seek an advance tax ruling for the "new idea" the two developed for TAPSF syndications. (Although the lawyer deposed prior to trial that no draft of the ruling request was attached as a schedule to the agreement, he testified at trial that it was.) If the ruling could not be obtained, there would be no charge for the firm's fees. If the ruling was obtained, the firm would be retained to prepare the necessary offering memorandum and the lawyer would endeavour to obtain its approval of a fee arrangement based solely on subscription sales and with no minimum fee. Under clause 6 of the agreement, the lawyer was to receive 55 per cent of the first $2,000,000 of profits from "the transaction" and thereafter, 50 per cent.
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¶¶ 6 From the time he entered into this agreement, the lawyer could not meet the duty of loyalty of every lawyer to his client. In Ramrakha v. Zinner (1994) 157 A.R. 279 (Alta. C.A.), Harradence J.A. described the duty as follows:

A solicitor is in a fiduciary relationship to his client and must avoid situations where he has, or potentially may, develop a conflict of interests: . . . . The logic behind this is cogent in that a solicitor must be able to provide his client with complete and undivided loyalty, dedication, full disclosure, and good faith, all of which may be jeopardized if more than one interest is represented. [para. 73; emphasis added.]

(I emphasize the phrase "where he has, or potentially may develop" to make the point that even if the agreement, properly construed, had given the lawyer an option to acquire an interest, as opposed to an immediate entitlement, the conflict would arise immediately.)

The law firm was not advised of the new business directly, however, at some point (paragraph 30) rumours started moving through the law firm and the solicitor gave the law firm a less than fully candid description of what was going on. Nevertheless, the law firm was probably on notice that there was some possible conflict and (perhaps) they should have investigated further.

In any event, the Court of Appeal asked for further submissions with regard to the law firm’s potential liability noting, however, "that the personal innocence of a person vicariously liable for the wrongful act of his partner was not relevant for the purpose of determining contribution proceedings between that person and another wrongdoer, even in cases of dishonesty." (Para. 93) The relevant sections of the case respecting the law firm’s potential liability are set out below. The key point, however, is that the law firm is exposed to a vast liability which would not appear to be covered by professional negligence insurance as a result of the wrongful (and quasi secret) actions of one partner. Law firms, accordingly, are put on notice of the need to keep track of what all their partners are doing.

The relevant sections of the decision are as follows:

¶¶ 87 I come next to Monarch's assertion that the Davis law firm is jointly and severally liable with Mr. Strother, a former partner, for his breach of fiduciary duty. I begin by noting that in its Statement of Claim, Monarch made many of the allegations against Mr. Strother against Davis as well, including the allegation at para. 108 that Mr. Strother and his firm had had an obligation to advise Monarch "of the facts of the errors in the 97/98 advice and to recommend that Monarch seek independent legal advice, but, in further breach of their duties and obligations to Monarch, failed or neglected to do so." As well, Monarch pleaded at para. 114 that Mr. Strother was at all relevant times a partner of Davis and knew or ought to have known of his conduct in connection with the "new structure". At paras. 124-125, Monarch sought the return of legal fees it had paid Davis, and at paras. 122 and 126 and in its prayer for relief, it sought various equitable remedies as well as damages, including punitive, exemplary and aggravated damages against all defendants.

¶¶ 88 It is apparent from the transcripts that Davis defended Monarch's claims on the merits. On appeal, Davis's factum again speaks to the merits. Nevertheless, Mr. Nathanson in his oral submission raised an objection to the effect that Monarch had not pleaded vicarious liability and therefore could not at this late date seek to hold Davis liable for anything more than whatever profits or benefits the firm had received as a result of any breach of duty by Mr. Strother. In other words, the law firm could not, because of an alleged deficiency in Monarch's pleadings, be ordered along with Mr. Strother to account to Monarch for profits wrongfully received by Mr. Strother in the event of a breach of duty on his part.

¶¶ 89 With respect, this argument overlooks the purpose of pleadings - to state generally the material facts relied upon together with the relief sought - and wrongly assumes that conclusions of law are required to be stated. No authority was cited for Davis's argument, and as Ms. Basham noted in reply, the Statement of Claim alleges that Mr. Strother was at all relevant times a partner of Davis. The firm cannot claim to be taken by surprise by the assertion of joint and several liability for Mr. Strother's breach. In these circumstances, I would decline to dismiss Monarch's claim of vicarious liability on Davis's part based on this "pleadings" argument.

¶¶ 90 Monarch relies on the joint and several liability of partners for wrongful acts of their partners. Although Ms. Basham did not refer to it, this principle is of course codified by ss. 12 and 14 of the Partnership Act, R.S.B.C. 1996, c. 348:

12 If, by any wrongful act or omission of any partner acting in the ordinary course of the business of the firm or with the authority of his or her partners, loss or injury is caused to any person who is not a partner in the firm or any penalty is incurred, the firm is liable for that loss, injury or penalty to the same extent as the partner so acting or omitting to act.

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14 A partner is jointly and severally liable with his or her partners for everything for which the firm, while he or she is a partner in it, becomes liable under either section 12 or 13.

(See also R.C. l'Anson Banks, Lindley & Banks on Partnership (18th ed., 2002), at 334-342.)

¶¶ 91 It does not necessarily follow, however, that Davis is liable jointly and severally with, or in the shoes of, Mr. Strother for all the profits for which he must account to Monarch. Several questions arise. Is Monarch in fact asserting liability under the Partnership Act, or seeking only an equitable remedy against Davis? If the former, can it be said Mr. Strother was "acting in the ordinary course of the business of the firm or with the authority of [his] partners" when his breach of duty was committed? Can the firm be liable for profits he earned after he left the partnership? Can the firm be liable to disgorge profits Mr. Strother received, but which Davis did not? Does an accounting for profits come within the ambit of liability under s. 12? Does the fact that many or all the partners of Davis were not informed of, or aware of Mr. Strother's personal conflict of interest, affect their position? And, if the state of knowledge of the other partners of Davis is relevant, were any of those partners aware that Mr. Strother was breaching his duty to Monarch, or - perhaps more importantly - should any or all of them have been put on inquiry? Looked at from a greater distance, do the equitable underpinnings of ss. 12 and 14 mean that the new "flexibility" of equitable remedies applies here as well? Last, do the principles explored in Citadel General, supra, have any effect on the vicarious liability of partners (under the Act or otherwise)?

¶¶ 92 Unfortunately, we did not receive argument on these questions. I have therefore reluctantly come to the conclusion that we must request argument (which would be in writing unless any counsel wishes to make oral submissions) from counsel for Monarch and Davis on the foregoing issues and any other arguments counsel deem to be relevant to the question of the firm's possible liability. (Counsel for the other parties may also make submissions if they wish.) It may be that once we have received such argument, we will find it necessary to remit this part of the appeal back to the trial court so that any necessary findings of fact may be made; but on the other hand, that may turn out to be unnecessary in law. I would hope that any submissions will be made or filed within the next two months or so.

¶¶ 93 I do bring to counsel's attention the recent decision of the House of Lords in Dubai Aluminium Co. Ltd. v. Salaam [2003] 1 All E.R. 97, which confirmed that in s. 10 of the 1890 Partnership Act (U.K.), the wording of which is almost identical to the wording of our s. 12, the phrase "wrongful act or omission" is not limited to common law torts but may include a lawyer's breach of fiduciary duty. (The disgorgement of profits was not at issue, however.) Their Lordships also concluded that, to quote from the headnote, the "personal innocence of a person vicariously liable for the wrongful act of his . . . partner was not relevant for the purpose of determining contribution proceedings between that person and another wrongdoer, even in cases of dishonesty." Counsel will no doubt make of this case what they will.

* James C. Morton, Steinberg Morton Frymer.