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). 

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. 

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. 

Murky line between oppression and derivative actions

Has the “somewhat murky” line between the oppression remedy and the derivative action all but disappeared and should they be considered as one combined remedial device?  In Rea v. Wildeboer, 2015 ONCA 373, the Ontario Court of Appeal confirmed that there remains a bright line between the two types of actions and, while the two are not mutually exclusive, they have different legal foundations and purposes. 

The appellants were minority shareholders in a publicly-traded company and claimed that certain individual respondents breached their fiduciary duties and misappropriated corporate funds.  It was alleged that the respondents had caused the company to enter into non-market transactions on terms which personally benefitted them and were unfair to the company.  The appellants alleged that the acts constituted oppression and sought to leave to commence a derivative action against certain directors.

The respondents brought a motion to strike the oppression claims on the basis that any claims, if they existed, were only derivative in nature.  The chambers judge struck the oppression claims which was upheld by the Ontario Court of Appeal. 

The court confirmed the distinct purposes served by both proceedings, which were designed to counteract the impact of the rule in Foss v. Harbottle.  Legislation created two remedies with different rationales and separate statutory foundations: a corporate remedy and an individual remedy.

A derivative action is a minority shareholder’s “sword” to the protections offered by the corporate shield and majority rule.  The oppression action is designed to protect the individual interests of a “complainant” as a result of how the company’s affairs have been conducted. 

There are cases in which claims may overlap between the two actions, mostly involving small, closely-held corporations, where wrongs to the corporation could also have direct effects on a complaints.  However, the court held that the distinction between the two actions ought to be maintained, particularly given the important policy purpose served by the leave requirement for derivative actions.

The appellant argued that the distinction between a derivative and an oppression proceeding had been significantly moderated such that a complainant was be entitled to pursue an oppression remedy even where the wrong was to the company provided the shareholder’s reasonable expectations have been violated by conduct caught by oppression. 

However, to establish oppression there must be conduct that harms the complainant personally, not only the collectivity of shareholders as a whole.  The oppression remedy cannot be invoked where a reasonable expectation is alleged but does not establish that it was oppressive to the interests of the complainant in its personal capacity.  

The pleading only contained “bald claims” to support argument that there was harm to individual interests qua shareholder.  The allegations did not establish any harm to the appellants that was different than the harm suffered collectively by all shareholders. At the heart of the claims was an allegation of misappropriation of corporate property.  The substantive remedy claimed was the disgorgement of the ill-gotten gains back to the company.  In order words, the alleged losses were suffered by all shareholders and not any one shareholder in particular.  The appellants were required to pursue the claim by way of derivative action.