For the London Free Press – March 31, 2014
Read this at lfpress.com
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.