Lawyers Beware: Roth Estate v Juschka and the Need for Independent Legal Advice in the Context of Family Transactions

Roth Estate v Juschka, 2016 ONCA 92 [Roth] is a case where the circumstances under which advice was given to family members in the context of a share purchase did not purport to necessitate the provision of independent legal advice (“ILA”). The underlying transaction was a gift from Mr. Roth and his wife (the “Roths”) to his daughter and her husband (the “Juschkas”), placing them into a significantly more advantageous position than had the gift not been given. The only caveat was a condition attached to the gift that if broken would trigger the payment of a promissory note securing the condition.

Further compelling the conclusion that the transaction one-sidedly benefitted the recipients, was a provision in the wills of the Roths, forgiving the promissory note when both of them had passed away. When the Juschkas violated the condition of the gift to extract a further benefit from the arrangement, repayment of the promissory note was triggered. Since Mr. Roth had passed on by this point, his estate and his surviving spouse sued and brought a third party claim against the lawyer who conducted the transaction for breach of the note. The outcome of this suit resulted in liability for the daughter and her husband who had fiduciary duties.

While the trial judge found numerous facts on which to rely in order to relieve the lawyer from liability for failing to properly advise the Juschkas on the consequences of signing the note, the Ontario Court of Appeal (“ONCA”) disagreed. In doing so, the ONCA overturned the trial judge’s factual findings and held the transaction to be a share sale for consideration as opposed to a gift. While from a technical standpoint, the decision is sound, it overlooks what the parties were really trying to achieve, the rendering of a conditional gift, and the one-sided benefits received by the Juschkas at the Roths’ expense. This decision unnecessarily extends a lawyer’s liability in matters where closely knit family members engage in estate planning and tax restructuring to benefit close family members while also protecting others.

Issues and Reasoning

The transaction in question involved a grocery business purchased by the Roths and the Juschkas back in 1985. The Roths owned 51% percent, while the Juschkas owned 49%. Both operated the business and the profits were divided according to the above percentage ownership. When Mr. Roth became terminally ill, the Roths sought the advice of their lawyer to devise a transaction where they could convey their ownership interest in the shares to the Juschkas who would run the business. Contemplating that Mrs. Roth would outlive Mr. Roth by a number of years, they built in a condition to the gift that it couldn’t be sold, on penalty of a promissory note coming due and immediately payable for the then value of the Roths’ interest.

The reason was that the Roths were gifting only the shares, and not their entitlement to the profits. In fact, Mr. Roth sought to ensure that the Roths’ share of profits kept flowing to provide for Mrs. Roth, despite the Juschkas owning and managing the business. Otherwise it would have been too easy for the Juschkas to sell the business after Mr. Roth’s death, leaving Mrs. Roth destitute. The Roths’ intention was for the Juschkas to inherit the entire business after Mrs. Roth died. For this reason, they left the shares in their wills to the Juschkas. However, Mr. Roth wanted Mrs. Roth to have an income while she lived, hence the creation of the promissory note, as a form of security. These considerations were plain and evident in how the transaction was structured. The lawyer at the time even explained to the Juschkas that the Roths could change their wills and that they were guaranteed nothing by way of gift. The trial judge found the Juschkas to understand this term, which was uncontradicted by the ONCA.

Interestingly, the Juschkas couldn’t even wait to stop paying the Roths their profits until Mr. Roth had passed away. When a major supermarket chain bought them out for a considerable sum of money, they demanded from the Juschkas as a term of the purchase that they stop paying the Roths. Remember, the right to the income was not given to the Juschkas and in fact was reduced to reflect the fact that the Roths were no longer involved in the business. Mr. Roth worrying about his and his wife’s income, called in the note.

A trial ensued and Mr. Roth passed away at some point during the proceedings. In any event, the Roths won at trial and liability was found against the Juschkas for the note. They in turn sued the lawyer for negligent advice for failing to advise them properly on the consequences of the note. The trial judge found that the lawyer complied with his duties towards all parties involved and made several findings of fact that the Juschkas benefitted significantly from the transaction without any adverse risk, making it unnecessary for the Juschkas to seek independent legal advice on the effects of the note.

The ONCA found a number of palpable and overriding errors in the trial judge’s findings with respect to the lawyer’s liability, deciding to reverse the lower court’s decision. The ONCA’s decision ultimately turned on whether the transaction was really a gift or a share sale. The latter would have clearly triggered the lawyer’s duty to assess whether a conflict existed and act appropriately, which would entail withdrawing from representing the Juschkas or sending them for ILA.

The ONCA held that

had the Juschkas obtained independent legal advice, the lawyer would have exposed the pitfalls in the deal and suggested alternative responses that the Juschkas could have presented before they agreed to be bound. In my view, it was a palpable and overriding error for the trial judge to find that the Juschkas would have signed the documentation ‘whether they had gone to another lawyer or not.’ There was no evidence to support that conclusion (Roth, para 53).

The Court further held that “the Juschkas became liable to double-pay for the Roths’ 51% of the shares by paying them $1.7 million in consulting fees plus the amount of the promissory note. They were represented in the transaction by the same lawyer who acted for the Roths and they were not advised of the potential conflict nor sent for independent legal advice” (Roth, para 57).

An Unnecessary Extension of Lawyer’s Liability

While the ONCA relied on binding authority to conclude that lawyers should represent both parties to a share sale, in my opinion it mischaracterized the facts and ignored the importance of the legal form used to effect the transaction. The decisive factor should have been that the purported share sale lacked any real consideration.

The ONCA held that

although he expressed to the respondent that his wish was to benefit the Juschkas by allowing them to become full owners of the grocery business without interference from other family members, the ultimate transaction was in no way a gift of shares. The Juschkas guaranteed the Roths a significant income stream for life, while the terms of the promissory note ensured that until the deaths of both Harold and Marlene Roth, the Roths would be able to enforce it (Roth, para 37).

This holding is inconsistent with the other facts found by the trial judge that were not contested and further inconsistent with the intent of the transaction. While the transaction appears on its surface to be an exchange of the Roths’ shares for an interest bearing promissory note, this ignores the reason for using such an instrument in the context of what was intended to be a conditional gift. While the note’s value is related to the value of the shares—likely for tax reasons—a promissory note typically stand on its own.

Promissory notes are a unique type of document called a ‘negotiable instrument.’ Created by the Bills of Exchange Act, RSC 1985, c B-4, promissory notes require the promisee to pay a fixed amount by a certain date. While they can be entered into to secure a debt or a collateral obligation, they represent an unconditional promise to pay the amount on the face of the note plus the specified interest. Thus, whether or not the Roths had transferred their shares to the Juschkas, the note would have been enforceable. What was overlooked is that the promissory note, in this case, was used as the instrument of choice to preserve the unilaterality of the transaction. The reason is to effect the share transfer as a gift and not as a sale for consideration. Categorizing it as a sale conflicts sharply with the intent of the underlying transaction.

However, the Court was fixated on the consulting fees payable by the Juschkas to the Roths, holding that such payments not only constituted consideration for the shares but also double payment because the Juschkas were liable to pay the consulting fees and the value of the promissory note. In other words, the Court found the transaction to be potentially disadvantageous to the Juschkas because they would have actually had to remit a portion of the profits to the Roths and pay for the shares at some point in the future. Thus, the ironic conclusion here is that the lawyer should have advised them that the transaction was not a gift but something they would have to pay for. In the latter scenario they would not have been worse off and simply would have gained the business while deferring payment for 40 years. In theory, the business interest conveyed by the Roths could have been worth substantially more in the future than the value of the note. However, they were entitled to independent advice that the conveyance might not be free after all if they failed to comply with certain conditions.

Besides the redundancy of telling someone they can’t have something for nothing, this decision overlooks the broader context of the transaction. Before the transfer, the Roths were receiving a portion of the profits because of their ownership stake. The transaction puts the shares into the hands of the Juschkas purportedly for nothing, but there is a chance they might have to pay for them if one of two conditions are broken. Transferring the shares to their name in no way obligates the Roths to also allow the Juschkas to keep the profits. This is a separate interest that the Roths opted to retain instead of giving it as an additional gift along with the shares. In fact, the Roths reduced the amount to reflect their lack of involvement in the business. While the fairness of this could be challenged, this is where the inquiry should have focused. In any event, there is no indication that the fairness of the reduction would have necessitated legal advice.

Conclusion

This decision unnecessarily extends a lawyer’s liability in matters where closely knit family members engage in estate planning and tax restructuring to benefit close family members while also protecting others. The intent behind the transaction to give the shares as gift but to retain assurances that Mrs. Roth would be provided for was abundantly clear. Instead of viewing the promissory note, the payment obligations to the Roths and the share transfer as three separate legal transactions, the ONCA chose to view them as constituting a bi-lateral exchange and ultimately characterized the transaction as a share sale. This view is concerning from an estate planning context, because promissory notes are often used to create conditions to gifts. Whether this case could be appealed to the SCC is not clear, but it would be a good start to challenging a highly impractical result.