Royalty fraudsters can’t hide behind ‘corporate veil’

For the London Free Press – March 31, 2014

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The British Columbia Court of Appeal recently held the owner of a company personally liable for a fraud his company perpetrated against a company it had licensed technology from.

It’s rare for courts to “pierce the corporate veil” and find personal liability for owners and employees or companies, but they will if fraud is involved.

In this case, Mr. Zhu was the controlling shareholder of a company called JingJing. JingJing signed a license agreement with a company called XY, where XY gave JIingJing the right to use XY technology related to animal genetics. The fee for using the technology was an ongoing royalty paid to XY based on how much money JingJing made from using the licensed technology.

XY relied on JingJing to report JingJing revenues and to pay the correct amounts. But JingJing, Mr. Zhu, and two other employees falsified the revenue records and significantly underpaid XY.

It was clear that JingJing breached the contract by doing the false reporting. But the court also found that Mr. Zhu and the two employees who participated in the false reporting committed the tort of deceit by falsifying the records with the intent to deceive XY and pay it less than was actually owed. Mr. Zhu, the two employees and JingJing were held jointly and severally liable for the payment of damages exceeding $8 million.

Though it may seem odd to have a contractual arrangement where the price is paid based on metrics that only the person paying knows, it is not that unusual.

Things such as software licences and reseller agreements, and the use of technology in general are often paid for based on what the buyer knows about the usage of the product. For example, fees can be based on things such as the number of sales, revenue from sales, numbers of employees, numbers of customers, or even the number of servers the technology runs on.

In these types of arrangements, the contracts typically require the buyer to report on the payment metrics along with payment. Sellers often include audit rights allowing them to inspect the buyer’s records or systems to confirm the reporting is accurate.

Depending on the nature of the technology being licensed, and the way the seller sets it up, it may in some cases be possible for the seller to be able to monitor the use metrics itself and avoid the risk of buyer fraud.

The facts and law in this case were very complex and dealt with many issues other than the reporting fraud, but lessons from this decision include:

  • Company owners and employees cannot do fraudulent acts and hide behind the corporate veil. Arguing that the fraud was in the course of their regular duties won’t save them.
  • Businesses that get paid for their products and services based on use metrics should try to deliver them in a way that allows them to monitor the use themselves.
  • Contracts that rely on reporting should contain an audit provision.

Terms of use needs balance

For the London Free Press – April 2, 2012 – Read this on Canoe

Have you ever considered what a service provider – such as a cellphone company or social networking site – can do with the photos and other content you send or post using that service?

Sometimes the terms of use of the service provider are so broad they give the provider the right to use it for things such as their advertising, or to be able to sell user content for the service provider’s own gain.

Terms of use, or terms of service, are the rules we agree to when we contract to use a service. That might take the form of a written contract we sign when we purchase a cellphone, or the click-wrap agreement we click “I agree” to when we subscribe to a social media service such as Facebook or Pinterest.

Terms of use often include some form of licence or permission language stating what the provider can do with content users send or post using the service. Defining that is important to make clear what rights the service provider has to that content. In most circumstances, that licence language should grant the service provider rights to the content that it reasonably requires to provide its services.

Occasionally, these licence permissions are drafted overly broad and grant the service provider the right to do almost anything it wants with the content.

For example a cellphone provider was recently criticized for language that said it: “will be free to copy, disclose, distribute, incorporate and otherwise use the content and all data, images, sounds, text, and other things embodied therein for any and all commercial or non-commercial purposes.”

In most cases, such overly broad language is not a nefarious plot to acquire user content for the service provider’s own use or profit. It is more likely the result of contract drafting that has not been thought through properly.

The drafter was rightly thinking the terms of use needed some licence language to define what the service provider can do with the user’s content. And the language does indeed give the service provider the rights it needs. So from that perspective the clause works.

But the clause is a failure because it grants rights that the service provider doesn’t need, and doesn’t want. And it fails to look at the issue from the perspective of what uses a user would be comfortable granting to the service provider.

In other words, the clause does not balance the rights and needs of the parties.

So why would a service provider care, given that most people don’t bother to read terms of use?

Some people do read them, and eventually the language will end up being publicly criticized. That doesn’t bode well for the reputation of the service provider, and it may never know how many potential users voted with their feet and didn’t use their service because of the overly broad language.

Writing on wall for traditional signatures

For the London Free Press – August 22, 2011 – Read this on Canoe

The increasing use of e-signatures raises several questions about their suitability for legal documents

Adobe recently announced the acquisition of EchoSign, a web-based provider of electronic signatures and signature automation. If ink was used to finalize the deal, it had not even dried yet when RPost, a self-proclaimed pioneer of e-signatures, launched a lawsuit against Adobe and EchoSign for patent infringement.

News coverage of the lawsuit described how millions of individuals and businesses worldwide have been using this technology to remotely automate the entire signature process with the click of a button. This is all fine in theory, but, when parties to a contract are relying on it, will an e-signature hold up in court?

According to the Ontario Electronic Commerce Act (ECA), a legal requirement that a document be signed (with a very few exceptions, such as wills, powers of attorney for individuals, documents for land transfer, and negotiable instruments) is satisfied by an electronic signature. The question then is: what is required to meet the definition of a legally binding e-signature?

The act defines “electronic signature” as “electronic information that a person creates or adopts in order to sign a document and that is in, attached to or associated with the document.”

Similarly, the Personal Information Protection and Electronic Documents Act (PIPEDA) defines “electronic signature” as “a signature that consists of one or more letters, characters, numbers or other symbols in digital form incorporated in, attached to or associated with an electronic document.”

Although it’s possible to digitize handwriting so that it’s displayed as an image, an electronic signature doesn’t need to look like a handwritten signature or even contain the letters of the signatory’s name, as long as it’s “associated with” the document.

There are two basic legal requirements concerning the reliability of an e-signature that must be satisfied. It must be reliable to identify the person, and to associate the e-signature with the relevant electronic document.

So how do services such as EchoSign do that? Essentially, you load the document to be signed on to the EchoSign service, along with the email address of the person who is to sign it. The person identifies themself by logging in to an existing social media account, and clicks to sign the document. The service returns the document, along with details about the signature, including the date, the email account used by the signatory who created the document, where it was sent, who viewed it, how the signatory’s signature was verified, and to whom and when the signed document was returned.

If, for example, the signatory identified themselves with their Twitter account, it includes their Twitter identity and the image they use for their account.

While we may be used to actual handwritten signatures, one has to ask whether this type of process might be more reliable, and less prone to fraud than the traditional method, particularly where the parties are not together when it’s signed.

Cloud sevices – Is the bloom off the rose?

For the London Free Press – May 9, 2011

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Recent outages at Amazon and Sony’s PlayStation Network have left businesses and consumers without service for lengthy periods of time.

The tech press is full of articles suggesting the bloom is off the rose for cloud services and cloud providers are in denial about risks. These articles call on online providers to take financial responsibility and offer more than token services credits.

These outages have done more than just prevented gamers from playing. Services provided by Foursquare, Hootsuite, Discovr, the New York Times and others were affected by the “Amazonpocalypse”. Other businesses using Amazon were barely affected, as they designed their use with disaster prevention in mind.

One reason cloud services are inexpensive is that they come with no guarantees, and no liability on the part of the provider. That’s not meant to suggest online providers aren’t motivated to keep their services running. It’s bad for business if they don’t. But some are better than others, and problems can occur despite provider efforts.

If users expect financial responsibility and compensation for their losses in a failure, they can expect to pay more.

Online service provider user agreements contain limitation clauses that deny liability if the services don’t work. At most, there might be a refund for the cost of their services proportionate to the amount of downtime. If users want more, they can expect to pay for the provider’s insurance to back up the liability. And in practice. most users opt not to pay more for liability protection.

Anyone using online or cloud services needs to first consider how crucial the services are to them. What will the effect be if the service is disrupted for a short or long period of time, or if their online data is lost?

If such disruptions would have serious effects, then the user must take steps to control those risks.

For the risk of losing data, it might be as simple as keeping local backups, or keeping a mirrored copy at a different service provider at a different location.

To keep the service operating continuously, users should take a close look at how the service is provided, and plan their use in a way designed to survive failure.

In other words, assume things will fail, plan around that, and test to ensure the plan works.

Amazon, for example, has several “availability zones”. Amazon customers who were able to switch between them suffered only minor issues.

Another approach is to use multiple service providers based in different locations.

How sale conducted may finger liable party

For the London Free Press – June 14, 2010

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A UK court ruled it would be unfair to enforce a limitation of liability clause where the buyer relied on the company’s advice

Commercial software purchases can be major investments. If problems arise or the buyer ultimately finds the software is not the right solution, either the buyer or seller must bear the cost of the product, lost profits and additional staffing.

Software companies include limitation of liability clauses in their standard terms and conditions, but this has not stopped courts from awarding damages to buyers in some situations.

The recent United Kingdom court decision of Red Sky v. London Kingsway Hall Hotel suggests that how the sale is conducted may determine which party is liable.

The court said it would be unfair to enforce a limitation of liability clause where the buyer relied on the software company’s advice in deciding to purchase the product and the product was inappropriate for the buyer’s intended use.

The software in question was meant to provide reservations and point-of-sale functions for hotels. After installation, the buyer found it did not meet its needs, and replaced it with other software.

The court also said that standard terms including a limitation of liability clause are predicated on the fact that a prospective customer would investigate the software and make up its own mind whether to purchase based on demonstrations and the operating documents.

UK courts have placed a heavy onus on software companies to provide the buyer with all relevant information if they wish to rely on limitation of liability clauses. What is relevant or sufficient will necessarily vary from case to case.

But it is clear – at least in the UK – that software companies are expected to take steps to ensure that the buyer has a fair chance to assess the product before purchase.

In this case, the court said the limitation of liability clause was unfair under the UK’s Unfair Contract Terms Act, as the software was not fit for its purpose. Basically, the software vendor was not transparent enough to give the buyer enough information to make an informed decision on the suitability of the software for its particular needs.

In the end, the court found the vendor liable for 110,000 pounds in damages for software that it had been paid 50,000 pounds.

Though Canadian courts may not have gone this far based on the same reasoning, Canadian courts have found liability despite limitation clauses where they find them to be unconscionable in the circumstances. Unconscionable means that it has to be more than unfair or unreasonable. Essentially, courts won’t allow vendors or their products to be incompetent, or cavalier in their claims, then hide behind limitation clauses.

Every product vendor, whether it sells software, online services, or other products, clearly wants to market their products in their best possible light. But it is wise to be as transparent as possible about the products, especially when it comes to helping purchasers make buying decisions.

Giving formal notices by email raises legal issues

John Gregory has a good post on Slaw talking about a recent English case that considered when an email is received for the purpose of accepting an offer of a contract.

In some ways, it seems odd to discuss notices by email in a time where we talk about service of court documents by facebook and twitter.

But there are some real practical issues to consider when determining when an email is actually or deemed to have been received.  The date and timing can lead to major consequences for things like contract formation or termination.

For example, what if the email gets caught in a spam filter? What if the recipient doesn’t check their email?  What if the email address is no longer in use?  Does it make a difference if the recipient carries a smartphone after business hours?

When entering a contract that has a notice provision – don’t just add email (or facebook or twitter) to the list of acceptable notice requirements without putting some thought into these issues.

Ruling strengthens consumer protection law in Ontario

For the London Free Press – March 1, 2010

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Companies have been sent a clear message — deal with complaints because dispute resolution is too impractical to pursue.

A recent Ontario Court of Appeal ruling confirms an evolving trend to protecting consumers from enforcement of mandatory arbitration clauses in consumer agreements.

The plaintiff in Griffin v. Dell Canada alleged Dell had sold computers with latent defects that made them prone to overheating, power failure, inability to “boot up” and unexpected shutdowns.

Griffin sought certification of the case as a class action. In reply, Dell moved to stay the proceeding in favour of private individual arbitration under the mandatory arbitration clause in each consumer contract. The arbitration clause directed that complaints must be taken to the (now defunct) National Arbitration Forum in Minnesota.

Dell relied on sec. 7(1) of the Ontario Arbitration Act, which requires the court to stay a proceeding where there is a valid mandatory arbitration clause.

A lower court had dismissed Dell’s motion and conditionally certified the case as a class action. The appeal court dismissed Dell’s appeals and refused to stay the class proceeding.

The appeal court relied on provisions of the Consumer Protection Act that invalidate mandatory arbitration clauses in consumer contracts. These provisions took effect in 2005, after the consumer contracts with Dell were entered into. But the court chose to rely on them because damages did not arise until after the provisions took effect.

Interestingly, the court also ensured the rights of non-consumers within the class were protected. The Consumer Protection Act restricts the definition of a “consumer” to an individual who “acts for personal, family or household purposes and does not include a person who is acting for business purposes”. But the court found it unreasonable to separate the claims of consumers and non-consumers.

In applying the consumer protection law, the appeal court made a point of noting that Dell’s mandatory arbitration clauses were simply unfair to Canadian consumers.

Writing for the court, Justice Robert Sharpe said: “In my view, it is clear beyond any serious doubt on this record that staying any claims advanced in the action will not result in any of the stayed claims being arbitrated. I agree with the motion judge that there is a lack of reality to Dell’s argument that the claim should proceed by way of arbitration. There will be no arbitration. The choice is not between arbitration and class proceeding; the real choice is between clothing Dell with immunity from liability for defective goods sold to non-consumers and giving those purchasers the same day in court afforded to consumers by way of the class proceeding.”

The appeal court has sent a clear message that consumer rights must be taken seriously. Large corporations will now have more difficulty avoiding responsibility for addressing consumer complaints by making dispute resolution too impractical to pursue.

Court ruling backs oral contract

For the London Free Press – August 17, 2009

[Note: Due to a technical glitch, this column has not yet been posted on the Free Press or Canoe websites]

VERDICT:  A recent Ontario Court of Appeal decision showed that it’s possible to enforce oral contracts under the right circumstances 

Oral contracts can be difficult to enforce. As famed movie producer Samuel Goldwyn once observed: “An oral contract is as good as the paper it’s written on.” 

The absence of written documentation can make it very difficult to prove in court that an actual agreement was reached. The judge is left to decipher the intent of the parties based upon what they claim the arrangement was. This is often to the disadvantage of the person claiming an agreement existed, who may have a hard time showing sufficient evidence to prove it. 

But a recent Ontario Court of Appeal decision may lend strength to those trying to enforce promises made through an oral contract. In UBS Securities Canada, Inc. v. Sands Brothers Canada, Ltd. the court found that an oral agreement was sufficient to enforce an agreement to buy shares. 

A representative of the plaintiff, UBS Securities, agreed to an oral contract to buy shares from a representative of the defendant’s company, Sands Brothers Canada. The plaintiff then entered into an agreement to sell the shares to a third party, relying on the oral contract. 

The defendant refused to comply with the terms of the oral contract, claiming that the agreement had not been finalized in writing. The shares remained with Sands Brothers Canada and UBS Securities sued for specific performance to receive the shares for which they contracted. 

The trial judge found in the plaintiff’s favour, deciding that there was a binding and enforceable agreement between the parties. UBS Securities was granted specific performance of the contract, entitling them to the 100,000 shares they were promised. 

Sands Brothers argued UBS Securities was under a duty to mitigate (or reduce their losses) by buying replacement shares at the time of the breach of contract. However, the court found that similar shares were not readily available at the date the contract was breached, leaving them unable to mitigate. 

In addition to the judge finding the plaintiff to be a credible witness, two additional considerations swayed the court in reaching its decision.

First, the plaintiff’s case was enhanced by electronic communications made during the course of the negotiation. The plaintiff produced detailed exchanges, made before the oral contract, outlining specifics of the agreement. The e-mails traced the proposed agreement from its origin until it was nearly completed. 

The use of e-mail resulted in more evidence being available. It resulted in creation of a time-stamped record of interactions that could be used to recreate the intention of the parties. 

Second, the appeal court found that it was common practice in the securities industry to make binding agreements orally. The fast-paced nature of the securities trade makes oral contracts necessary for the market to operate efficiently. In the time necessary to reduce the agreement to writing, the impetus to complete the transaction may have passed. 

So, in some instances, an oral contract is better than the paper it’s written on.

Ignored contract is still in force, top court says

For the London Free Press – March 16, 2009

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The Supreme Court of Canada recently rejected a lower court’s decision that you can’t enforce a contract that you’ve demonstrated no intention to comply with.

In Jedfro Investments (U.S.A.) Ltd. vs. Jacyk Estate, the top court actually upheld the outcome of the Ontario Court of Appeal’s decision, but on very different grounds. The Court of Appeal decision was the subject of a column published Nov. 3, 2006 (see 11/06/ignoring-written-deals-risky).

In the Jedfro case, three investors entered into a joint-venture agreement to purchase, develop and sell property in the United States.

The investors bought the property using cash and a promissory note. They intended to make payments on the promissory note by selling lots. But when the real estate market plummeted, the investors couldn’t meet their payment obligations, and the noteholder threatened to foreclose.

The joint-venture agreement contained provisions to deal with such a situation by providing a method for one party to buy any of the other parties out.

But instead of this occurring, one of the investors paid off the note on behalf of the other two, with no new agreement as to how he’d be compensated.

One of the other investors agreed to a profit-sharing deal to compensate the investor for paying off the promissory note.

The third investor, however, couldn’t come to terms about what he’d give the payer, so the plaintiff sued the payer of the note, arguing he had breached the original joint-venture agreement under which all were to share proportionally any profits of the joint venture.

The trial judge dismissed the action, holding that none of the parties had relied on the joint- venture agreement and it was therefore inappropriate for the court to force the parties to abide by its terms.

The Court of Appeal upheld the trial judge’s decision, saying that if parties ignore the terms of a deal, they can’t later enforce the ignored terms against the others.

Essentially, the appeal court held that contracting parties can’t ignore an agreement when it doesn’t benefit them, then ask the court to enforce the same agreement when it does benefit them.

The matter was further appealed to the Supreme Court, which upheld the previous decisions but disagreed with the lower courts’ reasoning.

The top court held that there are many ways to discharge a contract, including by performance, agreement, frustration, or by repudiatory or fundamental breach. But unless a contract is discharged by one of these methods, it remains in force and the parties remain bound by it.

Specifically, the Supreme Court held that, “while the parties may have ignored the joint-venture agreement, the obligations under it remained in effect.”

This decision represents a significant effort by the Supreme Court to reel in previous case law and send a clear message that contracts will remain in force and binding on the parties until discharged.

In other words, simply ignoring a written contract will not make the agreement go away.

Fundamental breach confuses

For the London Free Press – October 29, 2007

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For more than fifty years, contract law has been haunted by the spectre of fundamental breach.

From its inception in the law courts of the United Kingdom in the 1950s it was controversial. In essence, it is a way for courts to look beyond a contract, or at least not to enforce limitation of liability clauses contained in a contract, to provide a remedy for very serious contractual breaches.

Regardless of the theory, we simply need to remember that no-one can hide behind a limitation of liability clause in a contract if they don’t perform at all, or fail miserably — even if the limitation clause is a typical one.

In more technical terms, if a party commits a radical breach of a contract — then uses an exculpatory clause to take all the benefits of the contract but none of the burdens — the courts will prohibit that party from relying on that exculpatory clause irrespective of how clearly it is drafted, because to do so would be unfair to the other contracting party.

To this day, legal theorists and even judges are unable to agree exactly what amounts to a fundamental breach of contract, or if such a thing should even exist.

In a recent article in the Canadian Bar Review entitled Return of the undead: fundamental breach disinterred, Richard F. Devlin, Associate Dean at Dalhousie Law School, looks at how the principle seems to stick around despite efforts by some judges to eliminate fundamental breach as a concept of Canadian contract law.

While judges, academics and lawyers struggle with the differences, theories, and appropriateness of the concept of fundamental breach, or alternate concepts such as unconscionability or good faith – the practical effects on the enforcement of contracts are virtually the same.

In one instance the doctrine of fundamental breach was used to prevent a storage company from relying upon a limitation of liability clause. Under questionable circumstances, after the rent on a storage locker fell behind, the storage company sold the goods contained within, valued at $60,000, to an auctioneer for $800. The court held this action amounted to a fundamental breach of the contract.

In another case, a company was hired to move household possessions. They left the moving truck parked on the street overnight without any security or monitoring and the goods were stolen. The court found they could not rely upon their limitation of liability clause as their breach of contract was unconscionable.

As the courts struggle with the concept of fundamental breach and some judges try to get rid of the concept entirely, the reality is that courts will find a way to provide remedies for significant breaches of contract by whatever legal theory is available to them.

Despite the uncertainty provided by the presence of the doctrine of fundamental breach, there is little question that limitation of liability clauses will remain standard fare. In most cases they serve a useful purpose and can be applied quite successfully. In the end, however, no one can safely hide behind a limitation clause in situations where they don’t perform their obligations under a contract at all, or fail miserably to do so.