Directors held in contempt of court

It is relatively rare for British Columbia courts to hold directors or officers of a company in contempt for sins of the company. In Axion Ventures Inc. v. Bonner, 2023 BCSC 213, the BC Supreme Court did just that, holding a company’s directors in contempt for failing to abide by a court order.

The order that the defendants were accused of breaching required the defendants to place any company shares they held (it was not clear if the directors personally held shares) or controlled in trust, pending the results of the litigation. The defendants failed to do so, claiming that compliance with the order would put them in breach of their contractual obligations with their U.S. lender.  

The three-part test for civil contempt is: (a) the order alleged to have been breached must state clearly and unequivocally what should and should not be done; (b) the alleged breaching party must have had actual knowledge of the order, and (c) the party allegedly in breach must have intentionally done the act that the order prohibits or intentionally failed to do what the order compels.

The standard of proof for contempt is high and all three elements must be proven beyond a reasonable doubt and not a balance of probabilities.

The court determined Rule 22-8(2) allows for the enforcement of its order against any directors and officers found to be willfully disobeying that order. Directors and officers have a duty to do everything that is reasonable to ensure that company’s compliance with a court order. The intentions of a director or officer who is a directing mind may be considered when determining whether the company had the requisite mens rea to willfully disobey a court order.

While the court agreed that contempt of court is a “heavy, blunt tool” and should be a “last resort to obtaining compliance,” it nevertheless held the defendants in contempt. The court found that the defendants could not prove that compliance with the order would result in a breach. At best, the defendants could prove that compliance with the order may put its parent company in breach of its contractual obligations. 

While penalties for civil contempt are typically proportionate and are generally imposed with a view to enforcing compliance, jail time is an option. This decision is a powerful reminder of the risks that directors or officers could face if they fail to take all reasonable steps to ensure corporate compliance with court orders.

 

You get the garnishing order...then you lose it: helpful reminders and pitfalls

A number of helpful reminders about pre-judgment garnishing orders come out in Justice Gomery’s decision in Shier v Copper Mountain Mining Corporation, 2023 BCSC 152.  

The employee was dismissed for cause. Before serving his claim for wrongful dismissal, the plaintiff obtained a pre-judgment garnishing order of $1.574 million. 

The employer successfully overturned the garnishing order. In doing so, Justice Gomery outlined helpful principles both respect to the substantive requirements for establishing a right to a pre-judgment garnishing order, as well as important practical reminders for this process.   

The plaintiff was the former CFO and had a written employment agreement outlining guaranteed and contingent compensation. The employee alleged he had liquidated claim of $1.574 million based on the terms of the agreement, as well as an unliquidated claim for damages for breach of the agreement.  

The garnishing order was overturned on the basis that it was not actually for a liquidated claim. The problem with the employee’s claim was that it asserted a debt claim of $1.574 million arising from the breach of the employment agreement, but also damages due to the employer’s breach of the agreement by withholding the $1.574 million. 

The court found that the employee could not claim both in debt and for damages for breach of the agreement, at least not where the claim for damages encompasses an allegation of damage suffered by non-payment of the debt. The two claims are inconsistent as the debt claim presupposes the enforcement of the agreement, while the damages claim presupposes the termination of the agreement.  

Assuming the employee was terminated without cause, he could claim for the amounts owing under the agreement, or treat his wrongful termination as a repudiation of the agreement and sue for damages. He could not do both.  

The true nature of the employee’s claims was for damages at large. This was fatal to his prejudgment garnishment order. This is a helpful reminder about the importance of pleadings, particularly the relief sought in a claim. While it may be tempting to cover the field and plead all possible forms of relief, this case demonstrates that to do so may have unintended limitations for pre-trial relief. 

The court also found that the garnishing order materials were deficient as they failed to attach the employment agreement. This evidence was material to the determination of the true character of his claim. This is a helpful reminder to ensure that all relevant material is included in the ex parte application. 

Andrew Crabtree named 2020 Benchmark Litigation Star

Crabtree Law is pleased to announce that Andrew Crabtree was selected as a “Litigation Star” in Benchmark’s 2020 guide to leading litigators in Canada.

Benchmark Litigation is the definitive guide to the world’s leading litigation firms and lawyers.
It provides law firm and lawyer rankings based on extensive interviews with litigators, dispute resolution specialists and their clients as well as analysis of the market’s most important cases and firm developments.

Leave to the Supreme Court of Canada sought on case involving corporate veil issues and complex garnishing orders

Does the issuance of shares create a debt?  Can the corporate veil be pierced where one company does not have control over the other company?  These are the central questions in an ongoing garnishing proceeding in Delizia Limited v. Sunridge Gold Corp. that has weaved its way through the Federal Court and the Federal Court of Appeal and is now the subject of a leave application to the Supreme Court of Canada.

Andrew Crabtree was counsel to Sunridge in all proceedings in the Federal Court with Bob Cooper, Q.C. We have been successful both at trial and on appeal.

Background

Delizia Limited entered into contracts with the state of Eritrea for the sale of various military equipment.  Eritrea did not pay and Delizia obtained a default arbitration award for approximately US$4 million.

Delizia subsequently registered the judgment in Canada and initiated garnishing proceedings in the Federal Court against Sunridge, which had operations in Eritrea.   A preliminary garnishing order (“PGO”) was issued and subsequently objected to by Sunridge.

Sunridge was developing a mine in Eritrea.  Under Eritrean law, it was required to incorporate an Eritrean company (“AMSC”) to perform the development.  The government of Eritrea was entitled to acquire up to 40% in AMSC at its election, which it elected to do.  Shares from the treasury of AMSC were issued to a company wholly-owned by the Eritrean government, after the PGO.  Sunridge owned the other 60% of the shares in AMSC through two foreign subsidiaries.

Sunridge and Eritrea subsequently entered into a joint venture agreement to share in the costs and decision-making process associated with AMSC and its mine.  Pursuant to that agreement, Sunridge, directly or through its subsidiaries, did not have absolute control over the operations of AMSC.

Did the Issuance of Shares Create a Debt?

Deliza argued that the issuance of shares from the treasury of AMSC to a company owned by the government of Eritrea violated the terms of the PGO as those shares constituted a debt due and owing by Sunridge to Eritrea.  In the circumstances, the AMSC shares could not have been issued directly to Eritrea.

Both the Federal Court and Federal Court of Appeal held that the issuance of shares did not create a debt due and owing as between Sunridge and Eritrea. 

At trial, the court held that the shares were issued to the Eritrean company by AMSC, and thus the only way in which Delizia could succeed was for the court to pierce the corporate veil in order to attribute the actions of AMSC to Sunridge.  The court found that there was no factual or legal basis to pierce the corporate veil, including the absence of conduct akin to fraud or complete control over AMSC by Sunridge.

At the Court of Appeal, Delizia argued that it was unnecessary to pierce the veil to hold that the issuance of shares created a debt between Sunridge and Eritrea. The Court of Appeal disagreed and held that the issuance of shares from the treasury of AMSC, even if for consideration that was less than fair market value of those shares, the transfer would not, in and of itself, create a debt owing from Sunridge to Eritrea that could be subject to the POG.

 

 

Crabtree Law successful in arguing for rare BC Securities Commission decision granting pre-hearing disclosure and stay

Can subjects named in an investigation order seek pre-hearing disclosure as well as a stay to prevent the Executive Director from reviewing materials seized under a search order?  In an unusual case, the Commission ordered the Executive Director to disclose certain documents relied upon in obtaining an investigation order and a business search order.  The Commission also ordered that the Executive Director be prohibited from reviewing materials seized following a search order pending further applications. 

Background

The applicants were all named as subjects in an investigation order relating to the trading of one company.  In conjunction with that order, the Commission issued a non-disclosure order under s. 148(1) of the Securities Act.  Ten days later, the Commission issued a search order and staff of the Executive Director searched the business premises of the subjects and removed various documents and records, as well as the cell phone of one of the applicants.

All of the applicants brought various disclosure applications relating to the issuance of the original and amended investigation orders as well as the search order.  One of the applicants brought an application for form of stay to prohibit Commission staff from reviewing materials obtained under the search order. 

Commission orders pre-hearing disclosure

The Commission ordered disclosure of all materials and evidence relating to the issuance of the investigation and search orders.  While the Commission noted that disclosure obligations without a notice of hearing are not triggered, it had the authority to require disclosure in the circumstances of this case

The orders used by the Executive Director to further its investigation were broad in scope and used a significant power (i.e. search order).  The Commission found that procedural fairness required disclosure in those circumstances in order to fully advance their applications that the investigation and/or search orders were done in violation of their Charter rights.  The impact of such disclosure would not be significant on the Executive Director’s investigation. 

Commission issues stay

The Commission held that it had authority to issue a stay pursuant to s. 171 of the Act and found that it would be a “form of variance” of the investigation and search orders.  The stay would be, in effect, a restriction on the application of those orders (i.e. restricting staff from reviewing materials obtained under that order).

The Commission held there could be irreparable harm on the basis of the “intrusive nature of the search”, the nature of the materials seized (the cell phone contained personal information) and “the fact that the intrusion is ongoing (the cell phone remained in the possession of the Executive Director).  If either order was held to be invalid, the applicant would suffer irreparable harm.

The Commission found that the balance of convenience favoured the stay as it would be limited in nature and not inhibit the Executive Director’s investigation powers in this or future cases to protect the public.

 

 

Shareholder loan or capital contribution? Make sure you know before advancing the money

Are those funds you put into the company a loan or capital contribution?  One would think such a question would be easy to answer.  However, the case of Ghassemvand v. Premium Weatherstripping Inc., 2017 BCCA 309, demonstrated that in circumstances where the original documentation is not clear, that question can become difficult and expensive to determine. 

The appellant/plaintiff was a shareholder and employee in the respondent company.  A shareholders’ agreement was executed by all shareholders which was not a model of clear drafting and included terms that were cut and pasted from the internet.  One of the key terms related to "capital call" contributions and provided as follows:

The company raises funds only by way of issuing shares and selling them to the shareholders. The shareholders will not be required to make loans to the company.

Shareholders are required to contribute cash (cash call) to provide sufficient funding to the corporation in proportion to their shares when the board of directors makes a cash call.

Over the years, the plaintiff contributed $180,000 to the company. 

On the advice of the company’s accountant, all funds provided by shareholders were treated as loans to the company.  However, after the accountant saw the shareholders’ agreement (which occurred after litigation had been commenced), he re-classified the funds as capital contributions on the basis that the agreement appeared to preclude shareholder loans.

The plaintiff was subsequently terminated from his employment.  The plaintiff sued for the return of $180,000 from the company on the basis that those funds were loans. 

Trial Decision

At trial, the judge held the funds were capital contributions and relied significantly on the accountant’s re-classification of those funds as investments and the fact that the shareholder’s agreement appeared to preclude a requirement for shareholders to loan the company money. The plaintiff appealed.

Appeal

A majority of the Court of Appeal concluded that the trial judge erred on the basis that he had not considered “all the surrounding circumstances” in the manner in which the funds were advanced to the company.   Importantly, the majority found that judge erred when he concluded that a loan must be supported by a shareholder’s agreement and in his reliance on the accountant’s re-designation.   

The characterization of whether funds are provided by way of loan or investment is primarily a question of fact.  The “substance of the transaction” has to be examined and all of the surrounding circumstances – not only the words used in documenting the transaction – should be considered.  If monies are initially advanced as a capital contribution, and it is later decided that such funds should have been advanced as a loan, the initial transaction must be undone and a new transaction entered into.  You cannot simply re-characterize it. 

The majority could not determine the true character of the funds and sent that back to trial for determination.

 

 

 

Crabtree Law successfully defends TSX-V company regarding mining option agreements

Crabtree Law successfully defended Sona Resources Inc. in a trial regarding the enforceability of two mineral option agreements (the “Agreements”).  In written reasons, Madam Justice Gray dismissed the plaintiffs’ claim in their entirety and awarded costs to Sona.

The plaintiffs owned certain mineral claims in northwestern BC and optioned those claims to Sona.  Over the course of several years, Sona invested approximately $6 million into the properties with a view to starting commercial mining production. 

Without any prior notice, the plaintiffs purported to terminate the Agreements in the fall of 2014 on the basis that Sona had allegedly failed to comply with certain terms, including a requirement to obtain a bankable feasibility study.  In addition, the plaintiffs argued that the failure to make a small annual royalty payment (approximately $10,000 for both Agreements) by May 2014 amounted to a breach of the Agreements.  The plaintiffs sought a court declaration confirming they were entitled to terminate the Agreements.

Sona defended the case on the basis that it had complied with the terms of the Agreements and that in the absence of a termination provision, a reasonable period of notice was required before the plaintiffs had a right to terminate in order to allow it time to complete the requirements of the Agreements.  Sona paid the annual royalty payments in December 2014 in compliance with the terms of the Agreements.  

The evidence demonstrated that Sona had undertaken a significant amount of work on the properties, all with the view to advancing the properties towards commercial production or, alternatively, to obtaining an assessment of the feasibility of commercial production. 

The court agreed with Sona's arguments and held that the Agreements were still valid and in force.  Sona did not breach any terms of the Agreements and it was entitled to a reasonable period of time to complete a bankable feasibility study and/or put the properties into commercial production. 

In the alternative, Judge Gray agreed with Sona that if it had breached any terms of the Agreements, it was entitled to relief from forfeiture as the magnitude of any breach (approximately $10,000 in payments) was far exceeded by the amount Sona had invested into the properties (approximately $6 million). 

BC Court of Appeal limits use of disgorgement remedy under Securities Act

In a lengthy decision released yesterday, the BC Court of Appeal concluded that the disgorgement remedy available under s. 161(1)(g) of the Securities Act is limited to those that where the particular wrongdoer has obtained an amount, or avoided a payment or loss, directly or indirectly, as a result of that wrongdoer’s contravention.  

The decision will likely make it more difficult for the BC Securities Commission to issue disgorgement penalties on a "joint and several basis" against multiple parties unless there is evidence establishing control and direction as between the parties (i.e. persons acting as alter egos of corporate entities).  This will ensure parties associated with a wrongdoer (i.e. spouse or partner) are not necessarily made a party to any disgorgement order unless there is evidence demonstrating they had some greater involvement in the underlying acts giving rise to the order.

The Court outlined the following principles regarding disgorgement remedies:

1.     The purpose of s. 161(1)(g) is to deter persons from contravening the Act by removing the incentive to contravene, i.e., by ensuring the person does not retain the “benefit” of their wrongdoing.

2.     The purpose of s. 161(1)(g) is not to punish the contravener or to compensate the public or victims of the contravention. Those objectives may be achieved through other mechanisms in the Act, such as the claims process set up under Part 3 of the Securities Regulation or the s. 157 compliance proceedings in the Act. 

3.     There is no “profit” notion, and the “amount obtained” does not require the Commission to allow for deductions of expenses, costs, or amounts other persons paid to the Commission. It does, however, permit deductions for amounts returned to the victim(s).

4.     The “amount obtained” must be obtained by that respondent, directly or indirectly, as a result of the failure to comply with or contravention of the Act. This generally prohibits the making of a joint and several order because such an order would require someone to pay an amount that person did not obtain as a result of that person’s contravention. 

5.     However, a joint and several order may be made where the parties being held jointly and severally liable are under the direction and control of the contravener such that, in fact, the contravener obtained those amounts indirectly. Non-exhaustive examples include use of a corporate alter ego, use of other persons’ accounts, or use of other persons as nominee recipients.

 

Can a creditor access funds earmarked for defrauded investors?

Can a company's creditors claim priority to funds frozen by the BC Securities Commission ("BCSC") and earmarked for distribution to defrauded investors?

The BC Supreme Court ("Court") held in a recent decision that investors held priority to $10 million in funds that had been frozen by the BCSC over the company's other creditors.  This decision highlights the powers of the BCSC to assist investors that have been defrauded by a company and the adverse impacts on the company's creditors.

Background

The BCSC found that Bossteam E-Commerce Inc. had contravened s. 57(b) of the Securities Act by engaging in conduct which perpetuated a fraud on investors (see 2014 BCSECCOM 325).  Bossteam purported to run an online advertising business and raised $14 million from more than 14,000 investors by selling shares and other instruments.  However, Bossteam was engaged in little or no active business operations, despite the false impressions that were advertised to investors.

The BCSC froze certain of Bosssteam and its principals bank accounts containing, over $10 million. 

Receivership Application & Claims Process

The BCSC applied to the Court for an order to appoint a receiver as trustee over the funds and establish a claims process for defrauded investors to apply for a return of investment funds.  The basis for the receivership order was that there was a constructive trust over the funds at issue in favour of the investors, and therefore the investors' claims took priority over those of other creditors. 

One of Bossteam's creditors objected to the receivership order and the priority it created.  The creditor argued that a constructive trust had not been established, that Bossteam was a real business (and thus the investors had obtained some value from their investments) and that there should not be any priority to investors as that would arbitrarily prejudice Bossteam's creditors.  Underlying the creditor's submissions was that there was no civil fraud perpetrated on investors which disentitled them to any special priority to the funds -- all creditors of Bossteam should share equally in the remaining funds.

The BCSC argued that (a) fraud had been established and (b) that a constructive trust could be imposed regardless of whether fraud and a corresponding loss.  This entitled the investors to a constructive trust over the funds.

The Court agreed with the submissions of the BCSC and noted that the BCSC found that Bosstream and its directing minds acted fraudulently and did not have a legitimate business,  which was the basis for soliciting investments.  The Court did not make a determination of whether the elements of fraud were made out as the receivership application was not an appeal of the BCSC's decision.

Given the flexible nature of the constructive trust remedy, the Court was satisfied that the conditions for a constructive trust were met in this case as:

1. Bossteam and its principals were under a legal and equitable obligation to use investment funds in the manner in represented to investors.  As a result of Bossteam's misrepresentations, investors were defrauded and Bossteam was unjustly enriched in the process;

2. The frozen funds represented an actual proprietary link between "what left the investors’ hands and that which went into [Bossteam’s] accounts";

3. The investors had a legitimate reason for seeking a constructive trust as a remedy on numerous grounds, including that damages would not be as meaningful a remedy; and

4. It was not unjust to impose a constructive trust even though other creditors would be subordinated in the process.  The collection of the funds at issue by Bossteam was done fraudulently and it was not unjust in all of the circumstances to grant priority to the investors over other creditors.

 

Can the dilution of a shareholder’s interest be the basis for an oppression claim?

In a decision of the British Columbia Supreme Court released last week, the Court reiterated that in a claim for oppression, a court must consider the reasonable expectations of the claimant and whether the claimant has proved those expectations were breached in an oppressive manner.  While a dilution could be the basis for oppressive conduct, the facts did not bear out in this case.

The petitioners became shareholders of the respondent, Eco Oro Minerals Corp., in November 2016. Three months later, they called a shareholders’ meeting with the purpose of replacing the board. The board set the meeting for April 24 and selected March 24 as the record date, being the date by which a shareholder must hold shares in order to be eligible to vote. On March 16, the board issued shares to other corporate and individual respondents by way of debt conversions.

The petitioners argued that the purpose of the March 16 share issuance was to secure sufficient “friendly” voting power and had the effect of diluting their shares. They argued that the issuance of shares was self-serving and restrictive of their voting rights, and on that basis, sought an order that such issuance was oppressive and should be set aside. They argued that they had a reasonable expectation that their share position would not be diluted.

The court rooted its analysis based on an examination of whether the board’s actions were in the best interests of the company, while giving deference to board decisions pursuant to the business judgment rule.  In analysing the best interests of the company, the court looked to transactions of the company that occurred prior to the petitioners becoming shareholders to provide context to the board decisions to convert the respondents’ debt.

As of 2015, the company’s main asset was a gold/silver mining project in Colombia. By February 2016, the mining project was no longer financially viable, on account of steps taken by the Colombian government. It initiated an arbitration against Colombia and so its main asset became the arbitration claim. It was in “desperate financial straits”, requiring significant funds to continue to pursue its arbitration with the government of Colombia. Between July and September 2016, three of the respondents injected significant capital in exchange for, among other things, unsecured convertible notes.

The Court held on the evidence that despite the timing, the primary purpose of the debt conversion was debt reduction. It held that it was always the company’s intention that the respondents be equity participants and it was reasonable that the conversion occur prior to the record date in order that they may participate in the election of the board. There was no evidence that the conversion was not in the best interests of the company, and the conversion was permitted by the investment agreements of which the petitioners had full knowledge when purchasing their shares. Finally, the Court noted that the petitioners are “sophisticated investors and invested in Eco with their eyes open…”.

This case confirms prior decisions that a board can dilute a shareholders’ interest where the steps taken are in the best interests of the company. The risk of dilution highlights the importance of considering your rights as a shareholder (particularly whether you have pre-emptive rights to preserve your pro-rata share ownership) when purchasing shares in order to avoid the potential of dilution.

 

Can a court order the sale of a company's principal asset in a derivative action to break corporate deadlock?

In a derivative action, can the court order the sale of a company's principal asset pursuant to s. 324 of the Business Corporations Act?

The BCSC concluded it could not in Phoenix Homes Limited v. Takhar, 2017 BCSC 699.  In the face of a corporate deadlock, a company's principal asset could only sold pursuant to the terms of s. 324 of the BCA, which did not apply to a derivative proceeding. 

Phoenix Homes was owned by two shareholders and was deadlocked.  One of the shareholders obtained leave to commence a derivative action in the name of the company against the other for misappropriation of business opportunities.

The petitioner applied to have the court sell the company's principal asset.  The petitioner alleged the respondent had caused the company to enter into a sale agreement with a third party for that project at less than fair market value.  The petitioner wanted the court to order the sale of the land to take advantage of current real estate conditions.  The third party had filed a claim seeking specific performance of the agreement. 

The petitioner argued that the court could order a sale despite the action for specific performance on the basis that the third party action had little prospect of success.  The issue with this argument was that the court, acting pursuant to Rule 13-5, did not have discretion to make, in effect, a final decision on the merits of the specific performance claim at this stage. 

The court held that an application pursuant to s. 324 would only be available in a liquidation or dissolution of the company after the derivative proceeding.  Aside from a liquidation or dissolution, s. 324 was only available in an oppression proceeding.  The petitioner shareholder's oppression claim had already been dismissed by a prior decision.

Is it an oppression claim or a derivative action?

What is a disclosable interest and what kind of harm does a shareholder have to suffer in order to bring an oppression claim rather than a derivative action?  In Jaguar Financial Corporation v. Alternative Earth Resources Inc., 2016 BCCA 193, the Court of Appeal clarified the law on disclosable interests and examined the sometimes blurry line between oppression and derivative claims. 

Two petitions were under appeal.  The hearing judge concluded that the appellant company had acted oppressively against the respondent shareholder.  Petition #1 concluded that a proposed merger (to be completed without shareholder approval) was unfair and prejudicial to shareholders on account of, among other things, that the directors had a disclosable interest in the transaction and shareholder approval was required since it would change the appellant company’s objectives.  The judge prohibited the merger from completing (pursuant to s. 150 of the Business Corporations Act, S.B.C. 2002, c. 57 (“BCA”)) until shareholder approval was obtained at the next AGM.

Petition #2 centred around the company’s purported failure to abide by orders in the first petition and a proxy fight resulting from the shareholder’s attempts to replace the incumbent directors.  The company retained a proxy advisor and established a special committee.  The shareholder alleged that the company acted oppressively during this process through, among other things, excessive spending, disregarding orders from Petition #1 and issuing misleading communications.  The judge agreed and, again, held that the company had acted oppressively and made various orders enjoining the company from certain actions.

At issue in both petitions was whether the shareholder’s interests were uniquely impacted from that of other shareholders or whether the matter was more appropriately brought as a derivative action on behalf of the company. 

The Court of Appeal overturned both judgments.  On Petition #1, the Court of Appeal concluded the directors (except one that did disclose his special remuneration) did not have a disclosable interest pursuant to s. 147(4) of the BCA simply because they would be continuing as directors in the new company.  A transaction does not create a disclosable interest “merely because” it includes a provision regarding the remuneration of a director or officer – something more is required, such as excessive remuneration.  There was no evidence the fees or benefits under the transaction would be excessive. 

The court then proceeded to examine the findings of oppression made by the hearings judge on the basis of four shareholder expectations that had been breached.  The court went through each of those expectations, involving dilution, disclosure, change of business objectives and conduct of the AGM, and overturned the findings that the shareholder held reasonable expectations on any of these matters.

On Petition #2, a number of the issues were addressed given the Court of Appeal’s finding in the first petition.  One of the central issues was whether the shareholder should have initiated a derivative action since the harm complained of was suffered by all shareholders. 

The Court concluded that a derivative action was the appropriate vehicle and held that a shareholder must show it suffered harm separate and distinct from the harm suffered by all shareholders in order to proceed with an oppression claim.  The shareholder does not have to be the only shareholder that suffered harm to claim oppression, however “it must show peculiar prejudice distinct from the alleged harm suffered by all shareholders indirectly”.

The Court’s conclusion reaffirmed the rule of Foss v. Harbottle and outlined that oppression will not be available where a claimant does not suffer a separate or unique harm from that of all shareholders. 

Latest word from Supreme Court of Canada on oppression

Does the failure of a company to follow the legal formalities in the Canada Business Corporations Act, R.S.C. 1985 c. C-44 (“CBCA”) constitute oppression?  The Supreme Court of Canada revisited the oppression remedy and concluded that it did not.

In Mennillo v. Intramodal Inc., 2016 SCC 51, the majority of the court outlined that the failure to follow certain formal requirements of the CBCA did not amount to oppression.  The petitioner, one of two shareholders in the respondent, claimed he was oppressed as he was frozen out of equity participation in the respondent. 

The trial judge concluded that the petitioner had agreed to remain a shareholder in the respondent so long as he guaranteed the respondent’s debts.  The petitioner subsequently decided to stop guaranteeing the debts, resigned as a director and agreed to transfer his shares to the respondent’s controlling shareholder.  Through an oversight of that shareholder’s lawyer, the appropriate paperwork was not completed to transfer the shares.

The affairs of the respondent company were “marked by extreme informality”.  The transfer of the petitioner’s shares was not completed in accordance with the express requirements of the CBCA, including the endorsement of the petitioner on his share certificate. 

However, even though those formalities were not complied with, the court found the petitioner had no reasonable expectation of being treated as a shareholder after agreeing to transfer his shares.  The respondent’s failure to complete the “corporate formalities” did not constitute oppression and did not “strip” the petitioner of his status as a shareholder. 

The decision reflected the equitable nature of the oppression remedy and that cases ought to be judged on the basis of business realities and not technicalities.  However, the majority did not state that non-compliance with corporate legislation will never lead to an oppression remedy.  A larger company, particularly one that is widely-traded, would likely be held to a higher standard with respect to adhering to corporate formalities than the company at issue in these proceedings. 

When is a plan of arrangement fair and reasonable?

What is the role of a court in evaluating whether a plan of arrangement is fair and reasonable?  In InterOil Corporation v. Mulacek, 2016 YKCA 14, the Yukon Court of Appeal held that a court must ensure proper corporate governance has been conducted during an arrangement process and that shareholders have information that is adequate, objective and independent prior to exercising their shareholder vote.     

The target company entered into an agreement where all of its shares would be acquired.  Prior to the vote on that agreement, Exxon made an unsolicited bid at a higher price.  The company obtained a fairness opinion from Morgan Stanley, which received a fee largely contingent on approval of the plan, concluding it was fair and reasonable. 

At the court hearing, a dissenting shareholder argued that the plan was not fair and reasonable on a number of grounds, including that the fairness opinion was deficient.  The chambers judge noted that the board’s process in evaluating the plan had demonstrated “deficient corporate governance and inadequate disclosure”.  Further, the fairness opinion was “devoid of facts or analysis”.

Despite that, the chambers judge found the plan was fair and reasonable, particularly given the high (80%) shareholder support it received. 

The Court of Appeal noted that the decision about a plan belongs to shareholders, but the court retains a role to ensure that shareholders are in a position to make “an informed choice” on value they would be giving up and value they would be receiving.  The court noted that the financial advisor had not attributed any value to the company’s primary asset and the CEO and other members of the board would realize significant compensation if the plan was approved. All of this, along with the contingent fee agreement, undermined the utility of the fairness opinion.  The board should have obtained independent advice, including a second opinion, on a flat-fee basis.   

The chambers judge erred in ignoring the deficiencies of the fairness opinion and corporate processes engaged by the board, as well as failing to examine the “value” of the deal for shareholders. 

The court has a duty to ensure a shareholder vote is based on adequate and objective information that is free from conflicts of interest.  There were many factors which prevented shareholders from being properly informed in advance of the vote: absence of independent fairness opinion, failure of opinion to value chief asset, conflicts of interest of management, lack of independent special committee, and “lack of necessity for the deal”.  A court cannot blindly accept a shareholder vote without examining the basis upon which it was made. 

While accepting that “judges are not businesspeople”, the court held that it could not set aside the deficiencies it had identified and simply accept the shareholder vote.   Arrangements are generally approved by large majorities of shareholders.  However, a court has to be satisfied that the plan is “objectively fair and reasonable in a more general sense”. 

Derivative Actions: Best Interests of the Company

When is it in the best interests of a company to sue its directors and officers for improper disclosure?  This was the central issue in Arkansas Teacher Retirement System v. Lions Gate Entertainment Corp., 2016 BCSC 432, which dealt with an application for conduct of a derivative action. 

The petitioner was a shareholder in the respondent company and applied to bring a derivative action against various directors and officers of the respondent stemming from events in 2010 which were the subject of proceedings before the BC Supreme Court and Court of Appeal regarding a takeover bid launched by Carl Icahn.

The central argument of the petitioners was that the proposed defendants authorized, permitted or acquiesced in filings of US Securities Exchange Commission (“SEC”) mandatory disclosure documents that misrepresented and omitted material facts.  On account of those filings, the company paid a USD$7.5 million fine.  Through these actions, the petitioners argued the proposed defendants breached a number of equitable and legal duties to the company.  The petitioners argued that the company suffered damages, including the amount of the fine and the “credit, character and reputation” of the company. 

The company formed a special committee to review the proposed derivative action and concluded it would be harmful to the company and not in its best interests.

The company’s central argument was that the proposed action was not in the best interests of the corporation.  The costs of a derivative action had to justify the potential outcome to be granted leave.  The costs had to balance the potential recovery of damages (predominantly comprising the $7.5 million fine) and the legal fees incurred to defend the action (there were 12 proposed defendants, each of whom would be entitled to separate counsel). 

The focus of the court’s analysis was based on whether the proposed action was in the best interests of the company.   

Best Interests

The court’s analysis of best interests focussed on the following issues: (1) the company’s indemnification obligations; (2) reasonable prospects of success of the case; (3) amount of the SEC fine; (4) business judgment rule; and (5) independence of the special committee.

As a general principle, the potential benefits of starting a derivative action had to justify the cost of the litigation and the inconvenience to the company, in addition to demonstrating that a reasonable claim existed with an evidentiary foundation.  The financial well-being of the company is an important consideration in determining its best interests.

Indemnification

The rules under the BCA as to whether directors and officers are entitled to indemnification for a derivative action are “unclear and have not been extensively litigated”. 

The respondent argued that the directors and officers were entitled to indemnification against any damages and for legal fees pursuant to the company’s articles and contracts that had been executed by the company and directors and officers.  There was no evidence that any of their actions were done in bad faith.  A derivative action would be futile since the company would be required to indemnify the proposed defendants for any damages. 

The court outlined that the provisions of the BCA were unclear as to whether indemnification is permitted for derivative actions.  The court noted that s. 163(2) “appears” to prohibit indemnification in the context of a derivative action, but has not yet been judicially considered.  However, there is a conflict in the BCA as s. 164 provides that despite other provisions of the BCA a court can order indemnification for costs or liabilities.    

The court noted the policy objectives behind s. 163(2) as the “remedy of a derivative action would be futile if directors could breach their fiduciary duty, but be indemnified by the company when the company is awarded a judgment against them”.  However, the ambiguity arising between s. 163(2) and 164 made it “impossible to discern in what situations indemnification may be given, if any”.

While the court declined to make a decision as to whether indemnification was available he stated that it was “impossible to predict how s. 164 should operate at this time”.  The court went on to state “I do not believe that s. 164 should be used to supplement the poorly drafted s. 163.”

Reasonable Prospect of Success

The court found the petitioner’s claims had no reasonable prospect of success.  First, the disclosure issues had already been litigated and resolved before the Court of Appeal.  Second, none of the proposed defendants had been investigated by the SEC for any wrongdoing.  The fine at issue was levied against the company only.  Third, there were no facts pleaded to establish a breach of a fiduciary duty. 

Amount of SEC Fine

A lawsuit regarding the imposition of the SEC fine could not be in the best interests of the company given that it was a relatively small amount of money.  The harm of a derivative action to the company would not be worth the damages sought.

Business Judgment Rule

The court decided that the business judgment rule does not apply to all actions of the board.  For example, the board could not rely on the business judgment rule in its failure to meet its disclosure requirements, if a court ruled that the board had breached its duty of care.  Nevertheless, the court did accord deference to the special committee’s decision not to pursue the derivative action.

Independence of the Special Committee

The court rejected the petitioner’s argument that the special committee had to establish its independence and that it acted in good faith.  There was a presumption of good faith which had to be rebutted, which the petitioner was unable to do.   

Finally, the court noted that the commencement of a derivative action would constitute a breach of the settlement agreement that the company had entered into with the SEC.  The company was prohibited pursuant to that agreement from seeking to recover the fine paid to the SEC.  If the derivative action was authorized, the SEC would be permitted to re-investigate the case. 

When will excessive compensation constitute oppression?

When can the payment of management fees become oppressive?  In 1043325 Ontario Ltd. v. CSA Building Sciences Western Ltd., 2016 BCCA 258, the court concluded one director had authorized excessive compensation and ordered repayment based on expert evidence.

The trial judge found the majority shareholder concealed financial information and forged the signature of the minority shareholder on resolutions and waivers regarding audits and finances.  The court found the majority shareholder engaged in oppressive behaviour and ordered a buy-out of the minority shareholder.

The minority shareholder appealed on a number of grounds, including that the majority shareholder had paid himself excessive management fees.  The minority shareholder argued that the quantum of those fees either ought to be used in calculating the value of the shares or be paid out as damages, both of which the trial judge rejected.  The Court of Appeal analysed whether the payment of excessive management fees was properly framed as a personal action or as a wrong to the company. The court confirmed that a claimant must show "particular prejudice or damage" beyond a reduction in share value to succeed in oppression.

The court held that the payment of excessive fees in a closely-held company could constitute oppression.  The court found the payment of those fees was oppressive on the basis that the majority shareholder had treated the company as if it was his own and had engaged in deliberate conduct to conceal financial information.  Further, a derivative action would be counterproductive since it was a two-member company and would simply result in the return of fees to the company, which was controlled by the majority shareholder.

Based on expert evidence adduced at trial, the court set the fair compensation for services and ordered a pay-out of the excessive amounts in proportion to the minority shareholder’s interest in the company.

Family dispute or oppression dispute?

Is the oppression remedy available where the issues are the subject of a family law dispute?  In Ludwig v. Buzz Berry Production II Inc., 2016 BCSC 746, the court confirmed that the oppression remedy in the BCA is not available where the issues are the subject of a family law or personal dispute.

The plaintiff and the personal respondent were husband and wife and were the sole directors of the respondent company.  They owned 49% and 51% of the shares, respectively. The plaintiff brought an oppression action to compel the respondents to take certain steps in respect of banking and corporate records, among other things.

The parties were separated at the time of the petition. They participated in several television series projects together, through single-purpose companies. They entered in to a separation agreement that generally provided for a 49/51 split of any proceeds from two earlier projects for which the single-purpose companies had already been dissolved, despite the fact that the plaintiff was not a shareholder of the first company. 

One of the issues addressed by the court was the plaintiff’s request that a personal hard drive as well as external hard drives related to the various television productions be produced for review and copying, and further that the petitioner be provided access to certain documents. The respondents agreed to provide access to the hard drives and documents for copying at the petitioner’s expense.

As a result, the only evidence of oppression was the insistence that the petitioner bear her own costs for copying. The court decided the issues in the case were not related to the operation of the corporate respondent nor was the personal respondent using his powers as director to prejudice the minority shareholder. The court explained:

This is not a situation such as that discussed in Hui v. Hoa, 2015 BCCA 128, where the reasonably expectation of stakeholders in a corporation may be at risk of being prejudiced by analysing their rights through the lens of a family law dispute.

The court held that the oppression remedy is only available to address oppressive conduct in the person’s capacity as a shareholder, director, officer, even though the person may have other interests that are intimately connected to a transaction.  The court decided that the petitioner’s interests in the records of the dissolved corporations, as well as any interest in her personal hard drive, did not derive from her status as shareholder of the corporate respondent and so the oppression remedy was not available in the circumstances.

Limited partnerships and derivative actions

Is leave required to commence a derivative action on behalf of a limited partnership?  In Schmidt v. Balcom, 2016 BCSC 2438, the court noted this issue was “unsettled” in BC and held that the leave requirement for companies outlined in s. 232 of the BCA was applicable in the case of a limited partnership.  In Ontario, case law has held that leave is not required for limited partnerships. 

The applicants were investors in a limited partnership which was established to build senior care homes.  They alleged their investments were mismanaged and certain of the principals of the general partner had made fraudulent misrepresentations and breached various contractual and trust duties. 

With respect to the good faith requirement, the court outlined that the applicants had to bring the claim “primarily for the benefit of the partnership”. Leave could be granted where the “general partner fails to respond adequately, or at all, to alleged significant financial irregularity”.  The respondents had refused to respond to various requests for financial information about the investments and land transactions. 

The court concluded the proposed derivative action was in the best interests of the limited partnership and was being brought in good faith.  The derivative action was the only way in which a remedy could be issued if the allegations were proven.  

When will a court step in to break a corporate deadlock?

When is it just and equitable to liquidate and wind up a company by reason of director deadlock? The BC Supreme Court recently canvassed this issue in Kidner Investments Ltd. v. Totem Mercury Holdings Ltd. et al., 2017 BCSC 205. The court concluded that the directors and shareholders of the closely-held company could no longer work together and, without court intervention, the ongoing management of the company would be deadlocked which would not be in the best interests of the company. 

Background

The respondent company was owned equally by two companies, based on a structure set up in 1973 by two friends. The original owners died and their respective interests were left to their children. The company owned a large parcel of land near Cambie Street and Marine Drive, which had been leased since 1973 to car dealerships. The current lease expired in November 2017. 

The petitioner wanted to sell the land to take advantage of rising property values; the other director wanted to continue leasing the property to receive a regular income stream.   Over the course of 18 months, the land had risen in value from $12 to $25 million. The company had received a number of offers to purchase. 

The petitioner sought declarations that the directors were at a deadlock or, alternatively, that the affairs of the company, or powers of the respondent director, were being exercised in an oppressive manner. As for relief, it sought dissolution and liquidation of the Company or in the alternative that the respondent director be required to sell its shares to the petitioner.

Disagreements between directors

The evidence demonstrated significant disagreement between the directors which ultimately lead to corporate deadlock regarding the future direction of the company and its plans for the land.

The articles of the company did not provide assistance on this issue but only required a selling shareholder to first give the other shareholder a 30-day opportunity to purchase the shares before the shares could be sold to a third party.

The petitioner sought to engage in a process to determine the value of land for its eventual sale. The respondent refused the petitioner’s request to obtain an appraisal of the land. Similarly, the respondent refused to respond to any offers to purchase and expressions of interest the company received for the property.

The respondent argued the intentions of their fathers was to hold the land in perpetuity so that their children could have a regular income stream. While agreeing that the parties were at an impasse, the respondent’s principal argument rested on the fact that it would have to pay taxes upon the sale of the land and could incur unquantified “damages” on the sale. 

Rudderless Company

The court found that the relationship between directors had deteriorated and they were deadlocked in their future ability to make decisions necessary for the ongoing operations of the company. There was no need to make findings as to how or why the deadlock had arisen or to assess blame for it. The issue was determining the fairest or most efficient way to disentangle the parties.

Without court intervention, the ongoing management and operation will be “rudderless and deadlocked” and something had to be done in order to avoid an inevitable adverse outcome for the company.

The court rejected the respondent’s proposition that the status quo was in the company’s best interests. The lease expired in November 2017, there was no guarantee the current tenant would remain in an overholding lease and the petitioner was refusing to agree to a new lease. Further, the payment of taxes was not a basis to oppose the sale; taxes were not “damages”. There was no evidence that the sale would be improvident at this time. 

The court outlined that it would not use its equitable powers to enforce legal rights where the evidence showed a ready market for the sale of shares of a dissatisfied shareholder. Here, there was no market as no third-party purchaser would pay for a non-majority position in a deadlocked company without a significant discount. 

Since there was no ready market for sale of petitioner’s shares, the parties’ legal rights could be subject to an application of equitable powers. The court ordered that the land be marketed for sale. The court permitted each shareholder to have a right of first refusal to purchase the land or to purchase the others shares based on the value to be received from the sale. 

Director's Actions Oppressive

While not needing to decide the issue, the court concluded that the respondent director had acted in an oppressive manner by blocking attempts to obtain a land appraisal and preventing the company from responding to offers to purchase. 

The petitioner had a reasonable expectation that it could sell the land to enjoy benefits and legacy left by the shareholders’ father.  There was no evidence that the land would be held in perpetuity. In fact, the evidence demonstrated factors indicating its possible disposition over the years. Despite the fact that the land had been leased since 1973, this did not mean that it would not be in the best interests of the company to sell the land in the future. Practices and expectations can change over time.