Chapters Inc. v. Davies, Ward & Beck LLP

[Indexed as: Chapters Inc. v. Davies, Ward & Beck LLP]

52 O.R. (3d) 566 [2001] O.J. No. 206 Docket No. C35537

Court of Appeal for Ontario Goudge, MacPherson and Simmons JJ.A. January 26, 2001

Professions--Barristers and solicitors--Conflicts of interest --Disqualification--Confidential information--Law firm retained to act on amalgamation of two large retail book sellers--Law firm receiving confidential information--Law firm subsequently retained by another client with respect to an offer to purchase the shares of the former client--Former client establishing that old and new retainers substantially related--Law firm not meeting onus of showing that no confidential information from former retainer could be used against former client--Law firm disqualified.

Having acted for SmithBooks on its acquisition of Coles Book Stores Ltd. ("Coles"), the law firm DWB was retained in 1994 to act on the competition law issues arising from the transaction, which included the amalgamation of SmithBooks and Coles to form Chapters Inc. CG, a pre-eminent competition lawyer, was the lead lawyer for the retainer. During the course of the retainer, DWB received confidential information about the two companies, at that time the two largest retail book sellers in Canada, about their operations and their plans for Chapters. In the spring of 1995, the retainer was completed, and the Director of the Competition Bureau announced that the amalgamation would not be challenged but its effects would be monitored for three years. After April 1995, DWB did not perform any legal services for Chapters.

In 1998, DWB was retained by Indigo Books & Music Inc. ("Indigo"), a competitor of Chapters, to act on a competition matter involving Chapters. DWB concluded that it did not have a conflict of interest in accepting the retainer, but, as a matter of caution, it began institutional measures (a "firewall") and excluded the lawyers who had acted on the former Chapters retainer from acting on the new retainer for Indigo.

In November 2000, Trilogy Enterprises Ltd. ("Trilogy") made an offer to purchase 4,888,000 common shares of Chapters, and DWB was retained to act for Trilogy. The Trilogy offer contemplated an eventual merger of Chapters and Indigo. Initially, DWB maintained the firewall but, after careful consideration, DWB discontinued it, and CG joined the lawyers acting on the retainer. Chapters moved to have DWB disqualified on the grounds of a conflict of interest. Farley J. granted the application. DWB appealed.

On the appeal DWB submitted that: (1) because of fundamental changes in the Canadian retail book industry and in Chapters' business, the Trilogy retainer was not sufficiently related to the former Chapters retainer; (2) Farley J. had erred in finding that DWB had failed to discharge the onus placed on it to show that it received no confidential information from the former Chapters retainer that could be relevant to the Trilogy retainer; and (3) Farley J. erred in failing to consider the complete absence of risk of prejudice to Chapters from DWB acting on the Trilogy retainer.

Held, the appeal should be dismissed with costs.

The preservation of the confidentiality of information passing between client and lawyer is fundamental to the integrity of the administration of justice and the confidence of the public in it. The public represented by the reasonably informed person must be satisfied that no use of confidential information received in acting for the old client would occur in acting against the old client for the new client. If this possibility exists, the lawyer has a disqualifying conflict of interest. The onus of showing that the two retainers are sufficiently related rests with the client asserting the conflict of interest. To conclude that the retainers are sufficiently related, the court must find that in all the circumstances, it is reasonably possible that the lawyer acquired confidential information pursuant to the first retainer that could be relevant to the current matter. While there had been significant changes in the retail book business, the issues to be addressed in the current matter were the same. It was likely that at least some of the confidential information could be relevant to the current retainer. On the record of this case, Chapters demonstrated that the matters were sufficiently related. Further, and for the same reasons, Farley J. did not err in finding that DWB had not discharged the onus on it to satisfy the court that no information was imparted that could be relevant to the current retainer. Finally, Farley J. did not err in failing to consider the absence of prejudice to Chapters. The possible use of confidential information creates the risk of prejudice. Accordingly, the appeal should be dismissed.

APPEAL from an order disqualifying a law firm on the grounds of conflict of interest.

Cases referred to MacDonald Estate v. Martin, 1990 32 (SCC), [1990] 3 S.C.R. 1235, 70 Man. R. (2d) 241, 77 D.L.R. (4th) 249, 121 N.R. 1, [1991] 1 W.W.R. 705, 48 C.P.C. (2d) 113 (sub nom. MacDonald Estate v. Martin & Rossmere Holdings, Martin v. Gray, Gray v. Martin); Moffat v. Wetstein (1996), 1996 8009 (ON SC), 29 O.R. (3d) 371, 135 D.L.R. (4th) 298, 5 C.P.C. (4th) 128 (Gen. Div.), leave to appeal refused (1997), 1997 12309 (ON SC), 144 D.L.R. (4th) 188 (Ont. Gen. Div.); Westinghouse Electric Corp. v. Gulf Oil Corp., 588 F.2d 221 (1978)

Bryan Finlay, Q.C., for appellant. Mark A. Gelowitz and Allan D. Coleman, for respondent.

The judgment of the court was delivered by

[1] GOUDGE J.A.:--On November 28, 2000, Trilogy Enterprises Ltd. ("Trilogy") announced its intention to make an unsolicited offer to purchase 4,888,000 common shares of Chapters Inc. ("Chapters"). On December 11, the offer was mailed to shareholders. On December 18, Chapters commenced an application against Davies, Ward & Beck LLP ("Davies") seeking to disqualify it from acting for Trilogy in connection with this offer because of a conflict of interest. The application was heard by Mr. Justice Farley on December 22. On December 26, he released reasons for judgment allowing the application. On January 8, 2001, Davies perfected its appeal from this order and on January 19 the appeal was argued.

[2] Farley J. based his decision on the principles set out in the seminal case of MacDonald Estate v. Martin, 1990 32 (SCC), [1990] 3 S.C.R. 1235, 77 D.L.R. (4th) 249. He found that a previous retainer in which Davies had acted for Chapters was sufficiently related to the Trilogy retainer that Davies was required to show that no confidential information was imparted in the earlier relationship which could be relevant to the current retainer. He concluded that Davies could not meet this onus and must therefore be found to have a conflict of interest requiring its disqualification from acting on the Trilogy file.

[3] For the reasons that follow, I conclude that Farley J. was correct and I would therefore dismiss the appeal.

The Facts

[4] In 1994, FICG Inc. ("Smith"), which operated SmithBooks, moved to acquire Coles Book Stores Ltd. ("Coles"). The acquisition was successfully completed and on April 11, 1995, Smith and Coles were amalgamated to form Chapters. Davies was originally retained by Coles in connection with this transaction, but beginning on September 14, 1994, the firm was retained by both Coles and Smith with respect to the competition law issues arising from the transaction. These issues were of crucial importance because Coles and Smith were at that time the two largest retail book sellers in Canada and together dominated the market. The competition work continued until April 27, 1995 and since then Davies has not performed any legal services for Chapters.

[5] However, during the seven months of the competition retainer, Davies worked intensively with both Smith and Coles as they came together to create Chapters. The Davies team on this Chapters retainer was led by Calvin Goldman, Q.C., one of the best and best-known competition lawyers in the country. The team obtained a successful result. After a very thorough review, the Director of the Competition Bureau announced on March 21, 1995 that he would not challenge the transaction, but would monitor its effects closely for three years.

[6] In the course of providing advice on competition issues and dealing with the Competition Bureau, Davies received a very significant amount of confidential information and documentation about the two companies, their operations and their plans for Chapters. There is no dispute that, in respect of this information, Davies has a duty of confidentiality to both companies and, by virtue of the amalgamation, to Chapters. Equally, there is no doubt about the fact that Davies was given wide access to confidential information and documentation concerning Chapters and the two companies being amalgamated to create it. The nature of this information was described by Chapters as including the following:

(a) the retail book market and the respective positions of Smith and Coles in it, including confidential expert reports with respect to market share and definition, as well as assessments of the supply and demand sides of the market;

(b) assessments and estimates as to the size and relevance of non-traditional book retailers, such as department stores, pharmacies and convenience stores;

(c) barriers to entry into the relevant market, including the potential for large U.S. bookstore chains to enter Canada;

(d) confidential financial statements, reports, analyses and projections, as well as the strategic plans for the amalgamated corporation;

(e) calculations of efficiency gains resulting from the proposed merger, projected as much as 10 years into the future;

(f) the contractual arrangements of Smith and Coles, including information regarding exclusivity provisions in agreements with landlords of shopping malls, and other confidential and competitively sensitive leasing information, some of which is still in effect today (e.g. the lease for the World's Biggest Bookstore in Toronto, which is in close proximity to an Indigo store);

(g) trade terms, including purchase margins and the prospective purchase margins for an amalgamated corporation;

(h) information relating to the future strategy with respect to the development and creation of superstores in Canada that resulted in the formation of Chapters, a strategy which has not yet been fully implemented in the market, and which dealt in particular with the number of such stores the market could support, forecast economics for such stores and potential competitors to Chapters and how Chapters would respond to those competitive threats;

(i) costing of remedial measures that were or might have been required by the Bureau, including possible divestitures of stores or closing of stores; and

(j) highly sensitive strategic alternatives in the event that Bureau approval of the merger were not obtained.

[7] In December 1998, Davies was asked by Indigo Books & Music Inc. ("Indigo") to act on a competition matter involving Chapters. Indigo is also a large retail bookseller and a significant competitor of Chapters. Davies accepted the retainer and, while it concluded that it did not have a legal conflict as a result of the earlier Chapters retainer, as a matter of caution it put in place a "firewall" excluding from the Indigo file the lawyers who had worked on the earlier matter.

[8] In February 2000, Davies was retained by Trilogy in connection with its proposed offer for the common shares of Chapters. If successful, this offer contemplates a merger of Chapters and Indigo. The merged company would dominate the retail book market just as Chapters did.

[9] In the beginning, the firm kept the "firewall" in place but on October 11, 2000, after careful consideration, it removed this protection and Mr. Goldman and one of his colleagues who had worked on the first retainer joined the team engaged in the Trilogy file.

[10] The Davies retainer as counsel to the bidder Trilogy is a very broad one. It is to "quarterback" the transaction, to advise and strategize on the offer's structure, timing and price, to assess the Chapters response to the offer, to provide relevant tax advice and any necessary litigation assistance, and to give the required competition advice and deal with the Competition Bureau.

[11] In these circumstances, Chapters says that because of the earlier Chapters retainer, Davies has a conflict of interest which prevents it from accepting the Trilogy retainer. Davies denies this because it says that in the [5 1/2] years since the end of the first retainer there have been fundamental changes in the Canadian retail book industry and in Chapters' own business which make the confidential information irrelevant to the Trilogy matter.

[12] Farley J. applied the principles in MacDonald Estate, supra, and determined that Davies must be disqualified because of a conflict of interest. Davies says that in doing so he erred in three respects.

[13] First, it argues that Farley J. erred in determining that the Trilogy retainer was sufficiently related to the Chapters retainer to place an onus on Davies to show that it received no confidential information from the earlier relationship that could be relevant to the current file.

[14] Second, it says that Farley J. erred in finding that Davies had failed to discharge the onus placed on it.

[15] Third, it says that Farley J. erred in failing to consider the complete absence of risk of prejudice to Chapters from Davies continuing to act for Trilogy.

[16] A fourth issue was raised by Chapters, namely, the appropriate standard of review to be applied to the findings of Farley J.

[17] I will deal with each of these issues in turn.

Analysis

[18] Any consideration of these issues must be guided by the reasoning of Sopinka J. speaking for the majority of the court in MacDonald Estate. In that case, he laid out for the first time the approach to be followed in determining whether a lawyer is disqualified from continuing to act for a client by reason of a conflict of interest.

[19] The approach seeks to balance three competing values: the concern to maintain the high standards of the legal profession and the integrity of our system of justice; the countervailing value that a litigant should not be deprived of his or her choice of counsel without good cause; and finally (although it is not relevant in this case) the desirability of permitting reasonable mobility in the legal profession.

[20] Sopinka J. clearly saw the preservation of the confidentiality of information passing between client and solicitor as fundamental to the integrity of the administration of justice and the confidence of the public in it. His resolution to this problem gives this consideration precedence. Ultimately, public faith in the lawyers who staff the justice system depends on it.

[21] The question is not so much whether a lawyer acting for a new client against an old client offends an obligation of loyalty to the old client. As unseemly as it may appear in some circumstances for a lawyer to do so, this alone does not trigger a legal prohibition.

[22] Rather, the overriding policy focuses on the need for public confidence in the security of the cloak of confidence surrounding client-solicitor communications. The public represented by the reasonably informed person must be satisfied that no use of confidential information received in acting for the old client would occur in acting against that client for the new client. However, if this possibility exists, the lawyer has a disqualifying conflict of interest -- his duty to advance the cause of the new client conflicts with his duty of confidentiality to the old client.

[23] In light of these considerations Sopinka J. laid out the following roadmap to be followed to determine whether a lawyer has a disqualifying conflict of interest. At p. 1260 S.C.R. of MacDonald Estate he said this:

Typically, these cases require two questions to be answered: (1) Did the lawyer receive confidential information attributable to a solicitor and client relationship relevant to the matter at hand? (2) Is there a risk that it will be used to the prejudice of the client?

In answering the first question, the court is confronted with a dilemma. In order to explore the matter in depth may require the very confidential information for which protection is sought to be revealed. This would have the effect of defeating the whole purpose of the application. American courts have solved this dilemma by means of the "substantial relationship" test. Once a "substantial relationship" is shown, there is an irrebuttable presumption that confidential information was imparted to the lawyer. In my opinion, this test is too rigid. There may be cases in which it is established beyond any reasonable doubt that no confidential information relevant to the current matter was disclosed. One example is where the applicant client admits on cross-examination that this is the case. This would not avail in the face of an irrebuttable presumption. In my opinion, once it is shown by the client that there existed a previous relationship which is sufficiently related to the retainer from which it is sought to remove the solicitor, the court should infer that confidential information was imparted unless the solicitor satisfies the court that no information was imparted which could be relevant. This will be a difficult burden to discharge. Not only must the court's degree of satisfaction be such that it would withstand the scrutiny of the reasonably informed member of the public that no such information passed, but the burden must be discharged without revealing the specifics of the privileged communication. Nonetheless, I am of the opinion that the door should not be shut completely on a solicitor who wishes to discharge this heavy burden.

The second question is whether the confidential information will be misused. A lawyer who has relevant confidential information cannot act against his client or former client. In such a case the disqualification is automatic. No assurances or undertakings not to use the information will avail. The lawyer cannot compartmentalize his or her mind so as to screen out what has been gleaned from the client and what was acquired elsewhere. Furthermore, there would be a danger that the lawyer would avoid use of information acquired legitimately because it might be perceived to have come from the client. This would prevent the lawyer from adequately representing the new client. Moreover, the former client would feel at a disadvantage. Questions put in cross- examination about personal matters, for example, would create the uneasy feeling that they had their genesis in the previous relationship.

[24] Before dealing with the application of this roadmap to the issues in this appeal, there are two preliminary points to be made.

[25] First, while the hostile takeover bid that gives rise to this application is not a court proceeding, it is very much a legally regulated dispute between Trilogy, a current Davies client, and Chapters, a former Davies client. In these circumstances there is no doubt of the court's jurisdiction to entertain this application, seeking as it does the enforcement of Davies' duty of confidentiality to its former client. Indeed, no question of jurisdiction has been raised in this proceeding.

[26] Second, this is not a case where there is any suggestion that Chapters originally retained Davies in order to remove it as an adviser to a future opponent, nor is any suggestion made in this court that the present application was taken as a matter of pure tactics with no real concern for the possible breach of confidence. It is therefore not necessary to address the issue of the diminished duty that may result in such circumstances. Equally it must be made clear that, as counsel for Chapters said in argument, absolutely no question is raised about the honour and integrity of Mr. Goldman and his Davies colleagues.

[27] Turning then to the first issue, Davies says that Farley J. erred in finding that the Trilogy retainer was sufficiently related to the Chapters retainer to trigger the onus on Davies described by Sopinka J.

[28] I disagree. The determination of whether the two retainers were sufficiently related was not a matter of contention in MacDonald Estate because both retainers concerned the same piece of litigation. However, Sopinka J. clearly saw the counterpart American test of "substantial relationship" as a useful reference point. In Westinghouse Electric Corp. v. Gulf Oil Corp., 588 F.2d 221 (1978), a leading case on the matter, the U.S. Court of Appeals, Seventh Circuit set out the American test this way at p. 224:

The substantial relationship rule embodies the substance of Canons 4 and 9 of the A.B.A. Code of Professional Responsibility . . . Canon 4 provides that "a lawyer should preserve the confidences and secrets of a client" and Canon 9 provides that "a lawyer should avoid even the appearance of professional impropriety." As a result it is clear that the determination of whether there is a substantial relationship turns on the possibility, or appearance thereof, that confidential information might have been given to the attorney in relation to the subsequent matter in which disqualification is sought. The rule thus does not necessarily involve any inquiry into the imponderables involved in the degree of relationship between the two matters but instead involves a realistic appraisal of the possibility that confidences had been disclosed in the one matter which will be harmful to the client in the other.

[29] It is clear from MacDonald Estate that the onus of showing the two retainers to be sufficiently related rests with the client asserting the conflict of interest. It is also clear that it is not enough for that client to rest on a bald assertion that the retainers are sufficiently related. There must be clear and cogent evidence from which the court can reach that conclusion. See Moffat v. Wetstein (1996), 1996 8009 (ON SC), 29 O.R. (3d) 371, 135 D.L.R. (4th) 298 (Gen. Div.), leave to appeal refused (1997), 1997 12309 (ON SC), 144 D.L.R. (4th) 188 (Ont. Gen. Div.).

[30] In my opinion this inquiry must be guided by the need to avoid the evil addressed in MacDonald Estate, namely, the possible misuse by the lawyer of information acquired in confidence. Moreover, it is clear that the inquiry must be conducted in a way that preserves that confidence. There may be cases in which a simple description of the two retainers shows them to be so closely connected that the court will infer the possible misuse of confidential information and hence find the retainers to be sufficiently related. More commonly, as in this case, an outline of the nature of the confidential information passed to the lawyer pursuant to the first retainer will be needed. In the end, the client must demonstrate that the possibility of relevant confidential information having been acquired is realistic, not just theoretical. For the court to find that the retainers are sufficiently related, it must conclude that in all the circumstances it is reasonably possible that the lawyer acquired confidential information pursuant to the first retainer that could be relevant to the current matter.

[31] After examining the record, Farley J. concluded that Chapters had met the "sufficiently related" test. In my view, he was correct in doing so.

[32] It is clear that while engaged on the Chapters retainer Davies acquired a very significant amount of confidential information, including information relating to the nature of the retail book market, the nature of the business of Smith and Coles, the strategic plans for Chapters, projected efficiency gains for up to 10 years in the future, existing contractual arrangements, including long-term leases, some of which remain in effect, and prospective trade terms with suppliers. All this was necessary for Davies to receive and, with the help of its client, to fully understand in order to successfully perform its retainer relating to competition issues. The depth of the review conducted by the Competition Bureau made this essential.

[33] While a number of the documents received by Davies have since been made public by Chapters, many have not. Nor does it appear that the confidential discussions between Chapters and Davies in which information was passed have been publicly revealed.

[34] The core of the Davies position is that the nature of the industry and the nature of Chapters' business have both changed so dramatically since 1995 that the confidential information received in the earlier retainer cannot possibly be relevant to the current matter.

[35] I disagree. While there is no doubt that there have been significant changes, this is still about the retail book business. Even that portion of the information which may have been displaced by more current information would provide a historical basis for the more recent data and would possibly be useful for deriving trends relevant to the current situation. More fundamentally, just as Coles and Smith together dominated the retail book market in 1995, so Chapters and Indigo together would do just that today. The issues to be addressed today by the Competition Bureau will be the same as they were then and will require that the same kind of information be addressed. Only [5 1/2] years separate the Chapters retainer from the integral involvement of Mr. Goldman and his colleague in the Trilogy retainer. Moreover, it must be remembered that the latter retainer is extremely broad, requiring Davies to give advice on the full range of issues connected with the hostile takeover bid and Chapters' response to it.

[36] Given the nature and detail of the confidential information received, the limited time that has passed and the breadth of the current retainer, it is likely that at least some of that information could be relevant to the current matter. It is likely to be a part of the factual context directly informing Davies' advice to Trilogy and Davies' actions on Trilogy's behalf. Even if the information acquired earlier may not be publicly filed or disclosed in the course of the current matter, it will be relevant if it assists the lawyers to advance the cause of the new client against the old client.

[37] Looked at in this way, Chapters has demonstrated that it is reasonably possible that Davies received confidential information pursuant to the Chapters retainer that could be relevant to the Trilogy matter. I think therefore that Farley J. was correct in finding that Chapters has met the "sufficiently related" test.

[38] The second issue raised by the appellant is that Farley J. erred in finding that Davies had not discharged the onus on it to satisfy the court that no information was imparted which could be relevant to the current retainer.

[39] Again, I disagree. Sopinka J. made it clear that once the client has demonstrated that the previous relationship is sufficiently related to the current retainer, the onus resting on the lawyer will be a difficult burden to discharge, the more so because the lawyer must do so without revealing the specifics of the privileged communications.

[40] In my view, Farley J. was correct in finding against Davies on this issue. For the same reasons that yield the conclusion that it is reasonably possible that Davies received confidential information that could be relevant to the Trilogy matter, Davies cannot discharge the onus upon it. Particularly given the nature of the information received in working for Chapters and the scope of the Trilogy retainer only [5 1/2] years ago, Davies simply cannot show that none of that information could be relevant to the Trilogy file. Rather it is reasonably possible that some of it could be relevant. On this record the finding urged by Davies simply cannot stand together with the conclusion that the two retainers were sufficiently related.

[41] The appellant's third issue is that Farley J. erred in failing to consider the absence of prejudice to Chapters from Davies continuing to act for Trilogy. Davies argues that the subject matter of the current retainer is a takeover bid and submissions to the Competition Bureau, a public interest regulator, and since the public interest is at the centre of the retainer there can be no prejudice to Chapters.

[42] In my view, Farley J. did not err in this regard. In MacDonald Estate, supra, Sopinka J. was categorical in saying that a lawyer who has received relevant confidential information cannot act against his client or former client. There is no suggestion that this prohibition is limited to one particular kind of proceeding and is not applicable to a proceeding involving the public interest. The principles set out by Sopinka J. aim not at the nature of the proceeding, but at the possible use of confidential information by the lawyer to advance the cause of the new client at the expense of the old client. Such a possibility creates the risk of prejudice. To apply the reasoning of Sopinka J. to this particular set of facts, a lawyer who has relevant confidential information cannot quarterback a hostile takeover of a former client. Given that Davies has removed the protection surrounding that information by having Mr. Goldman and his colleague join the Trilogy team, the entire firm falls subject to this prohibition.

[43] Finally, the issue of the appropriate standard of review can be shortly dealt with. In my view, the conclusions of Farley J. that the two retainers are sufficiently related to cast the onus on Davies and that Davies could not discharge that onus are matters of judicial discretion. They are the product of applying a legal standard to the facts. As such, these conclusions would be subject to reversal on appeal only if, for example, Farley J. applied the wrong legal standard or based his conclusions on irrelevant factors or on factors to which he attached inappropriate weight. In my view, he did no such thing. Indeed, as I have indicated, I think he was correct.

[44] In the end, for these reasons, I would dismiss the appeal with costs.

[45] Finally, I would not want to conclude without expressing the thanks of the court to counsel for the high quality of their written material and their oral advocacy. In normal circumstances it would have been first class. Given the extraordinary time pressure under which this litigation was conducted, it was exemplary.

Appeal dismissed with costs.