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.

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). 

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. 

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.

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. 

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.

Family disputes within the corporation

When a family establishes a corporate structure for estate planning purposes, can the reasonable expectations of parents and children change over time?  This issue was squarely before the court in Hui v. Hoa, 2015 BCCA 128, where a son appealed a ruling that found his decision to eliminate a monthly income payment to his mother and her right to manage a company was oppressive. 

a.         Background

The mother and her late husband purchased properties when the son was a child through two holding companies (“Bon” & E&C).  They owned all of the voting shares and the son was issued a majority of non-voting shares. 

This structure was designed to give the parents control of the properties and income and to facilitate a tax advantageous transfer to the son upon the parents’ death or when they decided to give him control. 

There was no expectation that the son would manage or otherwise exercise control of Bon or E&C as a minor.  The son did not purchase any Bon or E&C shares and did not make a capital contribution to those companies.

The son was eventually appointed a director of Bon and expressed concern that his mom would leave her assets to her church.  In response, the mom cancelled the voting restrictions on his shares but otherwise maintained control and continued receiving monthly income. 

The son later requested that the mom relinquish her right to manage and to receive any income from Bon.  She refused.  

At Bon’s annual general meeting, the son used his voting control to, among other things, eliminate the payment of any compensation to his mom and remove her from management.

b.         Chambers Decision

The chambers judge noted that a shareholder’s reasonable expectations should be considered when the shareholder acquires its shares.   The chambers judge found that the son had no basis to remove his mom’s right to manage or receive income.  The son had no reasonable expectations to manage or control Bon’s affairs without his mother’s consent or until she died.

 Those expectations had to be viewed in light of the fact that he had paid nothing for those shares.  His only legitimate expectation was to take over the companies on his parent’s death or by consent.  The mom’s oppression claim was granted and she her right to manage and receive income was restored. 

c.         Appeal

The court overturned the decision as the son had not engaged in any oppressive conduct but had merely exercised his rights based on the existing corporate structure.  The mom did not have any reasonable expectations to continue receiving income in light of her decision to alter the corporate structure and provide the son with voting control.  She could have protected her expectation to a continued income stream through the creation of a trust or a shareholders’ agreement. 

The court noted that the oppression remedy “sits uncomfortably in the context of family disputes, where sometimes corporate positions are used as weapons” (at para. 38).  However, the focus must remain on the “corporate rights of the parties as stakeholders in the corporation, not as members in a family” (at para. 38). 

The focus of the chambers judge on the bona fides of the son’s conduct distorted the analysis of whether he was entitled to do what he did based on his shareholder rights. 

The rights of the mom and the son had to be analysed with reference to the existing corporate structure, not that which was originally put in place.  Initially, the mom’s expectation of receiving an income stream until her death was reflected in the estate freeze structure.  That expectation was changed when the mom transferred control to her son. 

The mom did not expect her son to cut off the income stream after making those changes.  However, those expectations were not reflected in the revised corporate structure and she did not institute any measures to ensure her expectations where protected.  In failing to do so, the mom’s “expectations of continued income from the company were no longer anchored to the corporate structure” and the chambers judge erred in concentrating on the mom’s expectation given the new structure (at para. 53).

The son’s decision to stop his mom’s income payments did not affect her rights as a shareholder.  The court noted that this conduct “may very well have been reprehensible in a family context, but this does not translate into corporate oppression” (at para. 52).