VIEWS: 10 PAGES: 81 POSTED ON: 10/8/2012
Tufo, Camion, Niziblian Summer 2010 I. TYPES OF BUSINESS ASSOCIATIONS a.) Sole Proprietorship o Single entity investor o Unlimited liability o Governance – mostly unrestricted o No perpetual existence Investment, Equity, Debt, and Trade Creditor o Investors in a business are persons who provide funds that are used to acquire assets that will be used in the business o Equity investor - right to receive a “residual” amount. o Creditors – i.e. Bank and trade creditors (persons who supplied goods or services on credit) - Entitled to receive fixed payments - Investments can be made in exchange for a virtually infinite variety of possible benefits Agency – Two Concepts o Legal Relationship - An agent is a person who affects the legal relations of another person, the “principal” - Can affect the legal relations by contract and by tort o Agency costs - A law and economics term referring to the costs that arise when the interests of the investor and the interests of the agent do not align b.) Partnership o Kramer has been operating the business for some time now. Many people come to the store and it is a success. Kramer wants to expand the business but all of his funds are tied up. o His buddy Newman has an excess amount of funds and is interested in partaking in Bro’s Buys. But he wants a say in how the business is run, so Kramer agrees to let Newman make decisions jointly with him. o The arrangement between Kramer and Newman is a partnership o Partnership involves more than one equity investor, each equity investor being referred to as a partner Default Rules o Rules in partnership are detailed in statutes but they represent default rules o Default rules are rules that the parties would have agreed to had they put their mind to the issue at hand o Statutory default rules thus minimize transaction costs by eliminating the need for parties to bargain for them o Parties are free, therefore, to contract out of the default rules o But where gaps exist in private contracts, default rules fill those gaps Types of Partnerships o Limited partnership – comprised of one or more partners whose liability is limited to the amount of their investment and one or more “general partners” whose liability is not so limited o Limited liability partnership - partners are not liable for the acts of their fellow partners or employees unless they were directly supervising the activity that caused the loss o Undeclared partnership – the de facto partnership where parties fail to register for a general or limited partnership; available in Quebec only c.) Corporations Key Features: 1 - Separate existence - Limited liability Allows for limited liability and management of business unlike limited partnership - Perpetual existence i.e. If Kramer and Newman were partners and sold their partnership interests to Elaine and Jerry, the Kramer/Newman partnership in the business would come to an end even if the business itself might be carried on by Elaine and Jerry in exactly the same way; wouln’t happen in a corporation Investors in a Corporation o Shareholders - Equity investors - Entitled to residuals; do not own assets of corporation - Entitled to certain rights such as shares in distribution of profits, distribution of the net proceeds of liquidation/dissolution, right to vote on important matters o Do Shareholders “own” the corporation? Management of a Corporation Insert Image d.) Other Business Associations o Limited liability companies (US) o Cooperative associations o Joint ventures o Franchises o Non-profit/societies o Unincorporated Associations II. AGENCY AND MANDATE Agency is the relationship that exists between two persons when one, called the agent, is considered in law to represent the other, called the principal, in such a way as to be able to affect the legal position of the principal Agency relationships are present in numerous transactions. It is hard to go through a day without encountering an agency relationship. CCQ 2130. Mandate is a contract by which a person, the mandator, empowers another person, the mandatary, to represent him in the performance of a juridical act with a third person, and the mandatary, by his acceptance, binds himself to exercise the power. The power and, where applicable, the writing evidencing it are called the power of attorney. Features of Agency 1.) The agent must be under the control of the principal - The greater the power of control over the agent, the greater the likelihood that the principles of agency are applicable 2.) Requires consent of principal and agent to the relationship - The parties can be held to have consented to an agency relationship "if they have agreed to what in law amounts to such a relationship, even if they do not recognize it themselves and even if they have professed to disclaim it." - Consent can be either express or by implication 2 Tufo, Camion, Niziblian Summer 2010 CCQ 2132. Acceptance of a mandate may be express or tacit. Tacit acceptance may be inferred from the acts and even from the silence of the mandatory. CCQ 2143. A mandatary who agrees to represent, in the same act, persons whose interests conflict or could conflict shall so inform each of the mandators, unless he is exempted by usage or the fact that each of the mandators is aware of the double mandate; he shall act impartially towards each of them. Where a mandator was not in a position to know of the double mandate, he may have the act of the mandatary declared null if he suffers injury as a result. 3.) Authority is given by the principal to the agent - Authority consists of what an agent can and cannot do, and how he can affect the legal position of the principal. Note: It is not necessary to use the term “agent” to describe the relationship. Likewise, a contract of agency is not needed to define the relationship Agency v. Employment o Agents have the right to enter into contractual relations on behalf of the employer. o An agent and an employee may not owe the same fiduciary duties to the employer. o A person who is an employee may also be an agent of the employer. o A person can be an agent without being an employee. Creation of Agency - Expressly by contract or mandate - Implicitly by conduct - Without a special contract - Without a contract in writing - Without anything having been expressly agreed as to terms of employment, remuneration, etc. - By estoppel Note: Estoppel is based upon detrimental reliance. A person who by words or conduct has allowed another to appear to the outside world to be his or her agent, with the result that third parties deal with that other as the first person's agent, cannot afterwards repudiate this apparent agency, if to do so would cause injury or loss to such third parties. Authority is the extent to which an agent can affect the legal relations of the principal. There are two types: 1) Actual 2) Apparent 1. Actual Authority The authority which in fact the agent has been given by the principal under the agreement or contract which has been made between them, or by virtue of subsequent ratification. - Can be express or implied - Does not require consideration - Two types: express actual authority and implied actual authority Express Actual Authority - The principal has stated either orally or in writing what the agent’s authority is - Authority that can be inferred from the written or oral words expressing the scope of the agent’s authority 3 Implied Actual Authority - The authority that the principal and agent would have expected the agent to have in the circumstances - This is part of an agent's actual authority, which the principal has consented, by implication, that the agent should have - Every agent has implied authority to do everything necessary for, and ordinarily incidental to, carrying out his express authority according to the usual way in which such authority is executed CCQ 2136. The powers of a mandatory extend not only to what is expressed in the mandate, but also to anything that may be inferred therefrom. The mandatory may carry out all acts which are incidental to such powers and which are necessary for the performance of the mandate. - Can be discerned from usual or customary authority - The usual authority of an agent is determined by looking at what the agent has been allowed to do in the past - If the agent has done certain things in the past that are outside the express authority of the agent, but the principal has allowed the agent to do those things, then the agent may be said to have usual authority to do those things Implied Actual Authority (Custom) - Determined by looking at the kind of authority agents of that type normally have - An agent can argue if there is an accusation that he/she did not have authority that agents of his kind customarily have the authority on which the agent acted CCQ 2137. Powers granted to persons to perform an act which is an ordinary part of their profession or calling or which may be inferred from the nature of such profession or calling, need not be mentioned expressly. - The custom must be: Known to the principal, or be so notorious that the principal cannot say that he has no knowledge of it Reasonable and lawful 2. Apparent Authority In Freeman and Lockyer v. Buckhurst Park Properties (Mangal) Ltd., Diplock L.J. explained that an "apparent" or "ostensible" authority was a legal relationship between the principal and the contractor created by a representation, made by the principal to the contractor, intended to be and in fact acted upon by the contractor, that the agent has authority to enter on behalf of the principal into a contract of a kind within the scope of the "apparent" authority, so as to render the principal liable to perform any obligations imposed on him by such contract. Establishing Apparent Authority 1.) The alleged principal must have made a representation, or permitted a representation, that the alleged agent had authority to act on behalf of the alleged principal 2.) A third party reasonably relies on the representation to her or his detriment. Note: The representation by the alleged principal can be express or implied from words, conduct or the circumstances. 4 Tufo, Camion, Niziblian Summer 2010 Consequences Once Authority is Established CCQ 2157. Where a mandatary binds himself, within the limits of his mandate, in the name and on behalf of the mandator, he is not personally liable to the third person with whom he contracts. The mandatary is liable to the third person if he acts in his own name, subject to any rights the third person may have against the mandator. CCQ 2158. Where a mandatary exceeds his powers, he is personally liable to the third person with whom he contracts, unless the third person was sufficiently aware of the mandate, or unless the mandator has ratified the acts performed by the mandatary. Obligations of the Mandator Towards Third Persons CCQ 2160. A mandator is liable to third persons for the acts performed by the mandatary in the performance and within the limits of his mandate unless, under the agreement or by virtue of usage, the mandatary alone is liable. The mandator is also liable for any acts which exceed the limits of the mandate, if he has ratified them. CCQ 2163. A person who has allowed it to be believed that a person was his mandatary is liable, as if he were his mandatary, to the third person who has contracted in good faith with the latter, unless, in circumstances in which the error was foreseeable, he has taken appropriate measures to prevent it. CCQ 2164. A mandator is liable for any injury caused by the fault of the mandatary in the performance of his mandate unless he proves, where the mandatary was not his servant, that he could not have prevented the injury. Ratification Where the agent acts beyond his or her authority the principal may nonetheless choose to accept what the agent has done by “ratifying” the act of the agent. Ratification means that the principal agrees with the performance of the action undertaken by the previously unauthorized agent. When this occurs, the ratification relates back, and the previously unappointed agent is treated as having been authorized at the time the act in question was performed. Circumstances in Which Ratification Can Occur A person can ratify a contract entered into by another person on their behalf if: a. The other person purported to act on behalf of the person who seeks to ratify b. The person who seeks to ratify was in existence and was ascertainable at the time the agent acted c. The person who seeks to ratify must have had the legal capacity to do the act both at the time the agent acted and at the time of the ratification. Requirements for Ratification o Ratification can be express, by conduct, or by acquiescence - An express ratification can be oral or in writing, by the conduct of the principal (any performance or part performance) or by acquiescence o Ratification must be based on a knowledge of all the relevant facts Consequences of Ratification 5 o The ratification relates back to the time of the offer and acceptance between the agent and the third party. o The principal can sue the third party and can be sued by the third party. o The agent is no longer liable for a breach of warranty of authority. o The agent is no longer liable to the principal for exceeding his authority. o The principal will be liable to the agent for reasonable remuneration and to indemnify the agent for expenses reasonably incurred by the agent in effecting the contract. Duties of Principal to Agent o Pay remuneration But generally requires an express agreement (since an agency relationship can be gratuitous) or circumstances in which the agent would not have been inclined to act gratuitously Requirement to pay the agent’s expenses and indemnify the agent against losses Duties of Agent to Principal The agent is said to owe certain fiduciary duties to the principal. These duties are implied terms of the relationship between the principal and the agent (and can be varied by express agreement/circumstances). These duties include: To perform/to obey: an agent, having been given definite instructions and agreeing to the terms of the instructions and the manner in which the instructions are to be carried out, has to follow them. Not to delegate: cannot employ another to perform his tasks. To perform with care and skill: not merely that which the agent in fact possesses, but rather such as is reasonably necessary for the due performance of his undertaking. Loyalty - An agent owes a duty of loyalty to the principal. The agent is obliged to act in the interests of the principal, not in his own interests (he can put his interests first only with consent of the principal). - Unless an agent has the consent of the principal, the agent may not make use for his own personal benefit the assets of the principal or info garnered from the principal. If anything of the principal’s is used, the profits thereof must be disgorged. CCQ 2146. The mandatary may not use for his benefit any information he obtains or any property he is charged with receiving or administering in carrying out his mandate, unless the mandator consents to such use or such use arises from the law or the mandate. Not to make secret profits (ex. a stockbroker is asked to sell shares for $10 per share but sells them for $12 per share and pockets the difference) To keep proper accounts CCQ 2147. The mandatary may not, even through an intermediary, become a party to an act which he has agreed to perform for his mandator, unless the mandator authorizes it or is aware of his quality as a contracting party. (to avoid conflict of interest and delegation) Remedies for the Breach of Agent’s Fiduciary Duties Transaction is void Agent is required to account to the principal for /disgorge any profits made in the transaction. Damages/injunction available to compensate for the losses caused by a conflict of interest (usually necessary against former renegade agents) CCQ 2146. If the mandatary uses the property or information without authorization, he shall, in addition to the compensation for which he may be liable for injury suffered, compensate the mandator by paying, in the case of information, an amount equal to the enrichment he obtains or, in the case of property, an appropriate rent or the interest on the sums used. 6 Tufo, Camion, Niziblian Summer 2010 Undisclosed Principal o A principal of whose existence the third party is unaware so that the third party does not know that the person with whom he is dealing is somebody’s agent. o An undisclosed principal can sue in his own name on an contract duly made on his behalf as long as the agent intended to act on the principal’s behalf. o BUT the third party may argue that the contract was made with the agent for personal reasons which induced the third party to contract with the agent to the exclusion of his principal or anyone else. o An undisclosed principal is bound by, or can claim under, a contract entered into by an agent acting with express authority (so if an agent exceeds his authority, no binding/claim possible) Principal Agent 3rd Party K CCQ 2165. A mandator, after disclosing to a third person the mandate he had given, may take action directly against the third person for the performance of the obligations he contracted towards the mandatary, who was acting in his own name. However, the third person may plead the inconsistency of the mandate with the stipulations or nature of his contract and the defenses which can be set up against the mandator and the mandatary, respectively. If proceedings have already been instituted against the third person by the mandatary, the mandator may exercise his right only by intervening in the proceedings. Liability of Principal for Agents’ Torts CCQ 1463. The principal is liable to reparation for injury caused by the fault of his agents and servants in the performance of their duties; nevertheless, he retains his recourses against them. Under the common law, principals are responsible for torts committed by their agents under the doctrine of vicarious liability. A principal is liable for a tort committed by his agent if the agent committed the tort while acting within the scope of his authority. The act in question must fall inside the express, implied or apparent authority of the agent. Lloyd v. Grace, Smith & Co. A clerk employed in the law firm of Grace, Smith & Co. defrauded a client, Emily Lloyd, of her sole remaining assets. Mrs. Lloyd owned two cottages and had loaned 450k to a Mr. Rushworth secured by a mortgage on a house. Mrs. Lloyd was dissatisfied with the income she was receiving from these investments. She called at the law firm of Grace, Smith & Co. to consult on this. She dealt with Mr. Sandles who was the firm’s conveyancing manager and managing clerk, and who conducted the conveyancing work of the firm without supervision. Although the name of the firm was Grace, Smith & Co., Mr. Smith was the only remaining lawyer of the firm and his time was largely taken up attending to his duties as an alderman. Mr. Sandles convinced Mrs. Lloyd to sell the cottages and call in the mortgage. Sandles left the room and returned 20 minutes later with two documents that he asked Mrs. Lloyd to sign. Mrs. Lloyd signed the documents without reading them over, believing they were something she had to sign before the sale could be proceeded with. The documents were in fact a conveyance by Mrs. Lloyd to Sandles of the cottages and a transfer of the mortgage. Sandles mortgaged the cottages to a bank for a loan from the bank and transferred the mortgage using the funds so raised to pay off personal debts. Mrs. Lloyd sued Smith. 7 Ernst & Young v. Falconi Falconi was a lawyer in the firm of Klein, Falconi and Associates (KFA). Falconi pleaded guilty to a charge under the Bankruptcy Act of assisting persons who were adjudged bankrupt in making fraudulent dispositions of their property. Klein had no personal involvement with the transactions. Each of the transactions involved the use of the legal services of KFA in the preparation of mortgage documents, documents transferring title to assets, corporate minutes, reporting letters and other services normally performed by a law firm in the course of a real estate or commercial practice. Klein argued that the acts of Falconi in assisting clients in making fraudulent transfers could not be considered within the ordinary scope of the business of the law firm. Policy Reasons for the Liability of the Principal for Torts Committed by the Agent Deterrence / Least Cost Avoidance - If a particular activity can cause harm then imposing the cost of the harm on that activity can serve to deter it. Allocation of the Loss to the Activity Causing the Loss - Increases the price of the goods or services provided through the particular activity that covers for the added cost of harm prevention and the cost of compensation for losses that are not avoided Concern for Compensation of the Victim - A plaintiff may have suffered a loss that a judge may feel is deserving of compensation. A particular defendant in the case may be the only source for compensation available. This may have an affect on the judge’s view of whether the defendant should be made liable. Termination o An agency relationship can be terminated by the act of the parties or by operation of law. o By Act of the Parties: - By the act specified in the agency agreement. - If not specified in the agreement, it is unilaterally terminable on notice (no concept of reasonable notice as in employment law) o Termination by Operation of Law: - Bankruptcy - Frustration (where the purpose of the relationship no longer exists) - Death Exercises Alfred is starting his own law firm. In preparation, he hires Bertha, an assistant to help put together the firm. A tells B to “go out and hire three associates”. What is B’s authority? Ted, a former associate at Anna’s old firm hears she is starting her own firm and calls to ask for a job. Anna tells Ted that Brad is taking care of hiring and immediately after, screams at Brad never to hire Ted, the biggest moron she ever worked with. Two weeks later, Brad is still having trouble finding associates. By chance, he runs into Ted who hands him a copy of a stellar resume and assures him how much he and Anna got along at the old firm. Brad hires Ted. Anna refuses to honour the offer to Ted. Did Brad have authority to hire Ted, and if so, what kind? What if Ted spoke only to Brad and not to Anna? Anna still tells Brad not to hire Ted, but doesn’t tell Ted that Brad is in charge of hiring. Ted hears about this nonetheless and Brad and Ted meet. Brad gives Ted his card which states his name and title, “Hiring Agent”. Brad hires Ted, Anna refuses to honour the offer to Ted. Anna decides starting her own firm is too much trouble. Instead, she becomes a silent, controlling partner in a two partner (including her) firm. A makes the other partner, Xavier, managing partner, but tells X not to 8 Tufo, Camion, Niziblian Summer 2010 hire any associates from Harvard Law school because she thinks they are too pretentious and make lousy lawyers. X meets Yola, a Harvard Law grad, at the bar he frequents and hires her. Shortly thereafter, X finds out he will be arrested for insider trading and skips town. Accordingly, Y loses her job, but finds out about A’s involvement. Y sues A. Who wins? III.PARTNERSHIPS Partnerships are a basic and essential form of business organization and are founded on trust. Their simplicity, tax treatment, and lack of formality make them an attractive option for individuals and small businesses. CCQ 2186. A contract of partnership is a contract by which the parties, in a spirit of cooperation, agree to carry on an activity, including the operation of an enterprise, to contribute thereto by combining property, knowledge or activities and to share any resulting pecuniary profits. Partnership v. Other Business Associations o Like a sole proprietorship, partners carry on their business directly o Unlike a sole proprietorship, more than one individual is involved o Unlike a corporation, the partnership does not have a separate legal personality o Partners are agents for each other and share unlimited liability Partnership Law o Governed by statutes, (Partnership Act in Ontario, Civil Code in Quebec) o The structure, management, rights, and obligations of the partners and the partnership are all a matter for agreement between the partners o In the absence of any agreement, the rules of statute govern o One of the matters that may not be contracted out of is the existence of the partnership itself Formation of a Partnership Civil Law CCQ 2187. The partnership or association is created upon the formation of the contract if no other date is indicated in the contract. Partnerships register at the Ministère du Revenu (Direction du registraire des entreprises) Common Law Cox & Wheatcroft v. Hickman A right to participate in profits affords cogent, often conclusive evidence that the trade in which the profits have been made was carried on in part for, or on behalf of, the person setting up such a claim. Nevertheless, the real ground of liability is that a trade has been carried on by persons acting on one’s behalf. When that is the case, one is liable to the trade obligations and entitled to its profits, or to a share of them. Cox & Wheatcroft v. Hickman (1860) Jurisdiction UK (HL) Facts An iron foundry, Smith & Sons, developed financial problems and could not pay off its creditors. Rather than force the business into bankruptcy, the creditors accept an arrangement whereby the assets of the business were transferred to trustees who were to run the business, pay off the creditors, and then return the assets to Smith & Sons. The creditors had access to the books, could elect and replace trustees, and make rules for the conduct of the business. Some goods were supplied to the business on credit and an invoice in favor of Hickman was not paid. As the business was insolvent, Hickman sought recovery not by 9 becoming another creditor, but by claiming against two of existing creditors, Cox and Wheatcroft, arguing that they were partners in the business because they were sharing in its profits. Issues Are the creditors partners in the business? Holding No. Ratio o The correct mode of stating the proposition is to say that the same thing that entitles one to profits makes one liable to debts, i.e. that the trade has been carried on on one’s behalf. o The real ground for liability is not the mere sharing of profits but that a trade is carried on on one’s behalf. o An arrangement under which creditors permit their debtor or trustees for the debtor to continue his trade applying the profits in discharge of their demands does not make them partners with their debtor. The debtor is still the person solely interested in the profits. The trade is not carried on by or on behalf of the creditors. Pooley v. Driver (1876) Jurisdiction UK Facts Borrett and Hagen entered into a partnership agreement to carry on a business of manufacturing grease, pitch and manure. The agreement provided for the division of capital into 60 parts. Profits were to be distributed in accordance with the number of parts attributed to each person. 17 parts were attributed to Borrett, 23 to Hagen, and the rest to persons who advanced funds by way of loan. The parts allocated to B & H were allocated to them as a means of compensating them for their work in the business. They did not provide any capital. The Drivers advanced L2500 on the terms of a separate deed that detailed the arrangements under which the loan was advanced to B&H. The loan agreement deed incorporated the terms of the partnership agreement between B&H and required B&H to observe the terms of the partnership agreement. The agreement also provided that the bankruptcy of the lender would result in the termination of the loan agreement. On liquidation of the partnership, the loan was to be repaid out of the assets of the partnership remaining after the payment of the other creditors of the partnership. The plaintiff, Pooley, was the holder of several bills of exchange drawn, indorsed, or accepted by B&H, which had been put into circulation for the purpose of raising money for the firm. When the firm went into liquidation, Pooley applied to Driver for payment of the money due on the bills on the ground that the above mentioned deeds constituted them partners in the firm. The Drivers claimed that they were mere lenders. Issues Are the Drivers partners in the firm? Holding Yes. Ratio o Partnership is the association of two or more persons for the purpose of carrying on a business together and dividing the profits between them. Normally, each partner contributes something, but dormant partners also exist. o Must always look at surrounding circumstances and what sort of intentions they point to. o It is a question of substance, not form. o The deeds gave the Drivers the same rights as would be had by dormant partners liable to a limited extent to loss, and with a guarantee of their capital from the active partners. o The intention was clearly to give the contributors all the benefits of partnership and to secure them from suffering the liabilities. o They intended to take the profits and they intended that the business be carried on on their behalf. The only thing they didn’t intend was to take on the liabilities - but tough luck. o Bovill’s Act stipulates that the advance of money by way of loan, even if the lender receives a rate of interest varying with the profits, or a share of the profits, shall not in and of itself constitute the lender a partner. But the person advancing the money must be a real lender. o The present case is not a transaction of loan as intended by Parliament. The true relation between the parties was that of active and dormant partners, not creditors 10 Tufo, Camion, Niziblian Summer 2010 and debtors. It was an ingenious device to shield them from the consequences of being partners, but it must fail. Comments The following factors indicate partnership and not simply a loan: - The alleged lenders were said to have an interest in the capital of the partnership. - The ability of the alleged lenders to enforce the terms of the partnership agreement - Having the return on the lender’s investment vary with the amount loaned - Terminating a loan agreement when a lender goes bankrupt - Having the term of the loan agreement coincide with the term of the partnership agreement was very unusual for a loan agreement Types of Partnerships CCQ 2188. Partnerships are either general partnerships, limited partnerships or undeclared partnerships. Partnerships may also be joint-stock companies, in which case they are legal persons. CCQ 2189. A general or limited partnership is formed under a name that is common to the partners. It is bound to make declarations in the manner prescribed by the legislation concerning the legal publication of partnerships; failing that, it is deemed to be an undeclared partnership, subject to the rights of third persons in good faith. CCQ 2190. In every declaration of partnership, the object of the partnership shall be set forth, together with the information prescribed by the legislation concerning legal publication of partnerships, and an indication that no person other than the persons named therein is a member of the partnership. In a declaration of limited partnership, the name and domicile of each of the known partners at the time the contract is entered into shall also be set forth, distinguishing which are general partners and which are special partners, and specifying the place where the register containing up-to-date information on the name and domicile of each special partner and all information relating to the contributions of partners to the common stock may be consulted. The Undeclared Partnership Agreement is the legal instrument used to evidence the operation by which people, called for the purpose of this operation the "participants," unite their efforts to successfully complete a commercial transaction. CCQ 2250. The contract by which an undeclared partnership is established may be written or verbal. It may also arise from an overt act indicating the intention to form an undeclared partnership. Mere indivision of property existing between several persons does not create a presumption of their intention to form an undeclared partnership. See CCQ 2250 – 2266 for Undeclared Partnerships. Undeclared Partnership o Each partner retains ownership of the property constituting his contribution to the undeclared partnership. o Each partner is liable for the debts and obligations of the other partners on an unlimited basis provided the debts have been contracted for the use or operation of the common enterprise. o The death of a partner leads to the end of the partnership for all partners Elements of Partnership (Ontario Partnership Act) A relationship between persons - Includes corporations Carrying on a business 11 - Includes every trade, occupation or profession - Does not necessarily include holding land together In common - Imposes an obligation on all partners to take responsibility for the authorized actions of their partners (silent and otherwise) With a view to profit - Doesn’t include non-profits Rules for Determining the Existence of a Partnership o The sharing of gross returns does not in and of itself create a partnership. o The receipt by a person of a share of the profits of a business is proof, in the absence of evidence to the contrary, that the person is a partner in the business, but the receipt of such a share or payment, contingent on or varying with the profits of a business, does not in and of itself make him or her a partner in the business o The advance of money by way of loan to a person engaged or about to engage in a business on a contract with that person that the lender is to receive a rate of interest varying with the profits, or is to receive a share of the profits arising from carrying on the business, does not in and of itself make the lender a partner with the person carrying on the business or liable as such, provided that the contract is in writing and signed by or on behalf of all parties thereto o A person receiving by way of annuity or otherwise a portion of the profits of a business in consideration of the sale by him of the goodwill of the business, is not by reason only of such receipt a partner in the business or liable as such LePage v. KamexDevelopments (1977) Jurisdiction Ontario (CA) Facts The appellants purchased property and incorporated a corporation to hold the property in trust for them in proportion to their interests. The corporation was to pay revenues and profits to them and they were liable to the corporation for any deficiencies. It was agreed that the sale or transfer of the interest of the appellants in the property to third parties could take place only after the others had been given a first opportunity of refusal. Any decision regarding the sale or other dealings with the property was to be made by majority vote. The appellants met monthly to discuss the operation of the property and the possibility of its sale. At some stage, the property was listed for sale via open listing. A decision was made by the appellants as a group that there should be no exclusive listing. Employees of the respondent then approached one of the appellants and he executed an exclusive listing agreement with them, signing on behalf of the other appellants as if they were a partnership. He had not, however, been authorized to do so. Issues Were the appellants a partnership? Held No, they were co-owners of the property. Ratio o Whether or not co-owners become partners depends on their intention as disclosed by all the facts of the case. o Must determine whether the intention was to carry on a business or simply to provide by an agreement for the regulation of their rights and obligations as co- owners of a property. o There is no intention to carry on a business in this case. o Each was at liberty to deal with his undivided interest in the land as his own. o They also kept their beneficial interests in the property separate for tax purposes. o Right of first refusal does not affect their rights to deal with their respective interests in the property. o The mere fact that co-owners intend to acquire, hold, and sell a building for profit does not make them partners. Comments Intent matters! Volzke Construction v. Westlock Foods (1986) Jurisdiction Alberta (CA) 12 Tufo, Camion, Niziblian Summer 2010 Facts The appellant, Volke, a general contractor, was building an extension to the Westlock Shopping Center. The final bill was not paid. Volke sued the respondent, Westlock Foods, claiming it was in a partnership with another firm, Bonel Properties, and therefore liable for the debt. Bonel Properties had approached Horne&Pitfield, an IGA franchisee, for H&P take space in the expanded Shopping Center. H&P’s main shareholder, Shefsky, did not want to be a tenant but an owner. He made an offer to Bonel for a 20% interest in the shopping center and Bonel accepted. A bank account was opened in the name of Bonel Properties and Westlock Foods. Only the principals of Bonel had signing authority. All accounts were submitted to Bonel and Volke was paid until Shefsky died. His wife carried on but was refused signing authority on the bank account. She sent tenants to Bonel, and Bonel negotiated the leases. Tenants made complaints about repairs and such to the manager of Westlock Foods. Bonel arranged to complete the repairs and paid the bills on the checks of Bonel Properties and Westlock Foods. The interim financing of the additions to the shopping center was secured through a mortgage signed by both companies. Issues Were Bonel and Westlock partners or co-owners? Holding They were partners. Ratio o Letter indicating purchase of a 20 per cent interest in the Westlock Shopping Centre o Shared costs of developing business of shopping center. o Spoke of each other as partners o Westlock and Mr. and Mrs. Shelfsy sent tenants to Bonel, received complaints, etc. o Division of profits o Bank account and printed checks o Financing for expansion Comments Control has nothing to do with the existence or non-existence of a partnership. Backman v. Canada (2001) SCC Jurisdiction Facts In 1985, a limited partnership was created by a number of US residents called the Commons. The Commons acquired land and constructed an apartment building, but the costs far exceeded the market value of the property. The appellant, a Canadian, sought to acquire these losses so that he could use them as a deduction in computing his Canadian taxable income. The appellant, other Canadians, and an Alberta corporation (the Canadians) arranged to become assignees of the interest of the original American partners in the Commons. In addition to becoming partners in the ongoing Commons partnership, they also purchased a one per cent interest in a Canadian oil and gas property. Issues Are the Canadians partners in the Commons? Holding No. Ratio The sole purpose of the Canadians in entering into the transaction was to acquire a tax loss. After they took up their assignments, no further business was carried on by the Commons, and there was no view to a profit. The entry of new persons and the departure of existing partners constitutes the creation of a new partnership provided the requisite conditions are satisfied. The oil and gas property was window dressing. The Canadians knew virtually nothing about it. It had no ancillary profit-making purpose. Carrying on a Business - Black’s Law Dictionary: to hold one’s self out to others as engaged in the selling of goods and services. - Alternately: i) the occupation of time, attention, and labor ii) the incurring of liabilities to other persons, and iii) the purpose of a livelihood or profit. - Business need not have been carried on for a long time - even a single transaction is sufficient. - The passive receipt of rent is also sufficient. 13 In Common - The fact that the management of the partnership rests with a single partner does not mean that the business was not carried on in common. - Can entail the contribution of skill, knowledge or assets to a common undertaking; a joint property interest in the subject matter of the adventure; the sharing of profits and losses; the filing of income tax returns as a partnership; financial statements and joint bank accounts; correspondence with third parties, etc. View to a Profit - Requires inquiry into the intentions of the parties entering into an alleged partnership - Important to distinguish between motivation and intention - Motivation: that which stimulates a person to act - Intention: person’s objective or purpose in acting - A tax motivation does not derogate from the validity of a partnership where the essential ingredients of a partnership are otherwise present. - It is sufficient to show that there was an ancillary profit-making purpose. - The law of partnership does not require a net gain over a determined period in order to establish that an activity is with a view to profit Comments Not a mechanical test, all factors must be considered in context. Whether a partnership has been established in a particular case will depend on an analysis and weighing of the relevant factors in the context of all the surrounding circumstances. Note: Strangely, the Court did not look into the issue of the assignment of the partnership interest in this case. Usually, this is not the way to become a partner because it gives one no say in the management of the firm, etc. Partners normally have to agree to someone new becoming a partner. CCQ 1525. The carrying on by one or more persons of an organized economic activity, whether or not it is commercial in nature, consisting of producing, administering or alienating property, or providing a service, constitutes the carrying on of an enterprise. Relationship Between Partners Statutory partnership rules can act as a type of standard-form contract. This facilitates the formation of partnerships by reducing transaction costs. The ability of partners to create their own set of rules to govern the relationships between them makes partnership a very flexible form of business association. Flexibility is viewed as one of the key advantages of partnership. Note: This is more true for common than for civil law. Contracting Out of the Civil Code Provisions on Partnership o It becomes a matter of interpretation whether this is permissible o Definitional provisions (CCQ 2186-97), provisions dealing with third parties (CCQ 2219 et seq.) likely cannot be contracted out of o Provisions governing relations between partners can likely be contracted out of, although some articles specifically contemplate it (CCQ 2202, 2212, 2215), while others forbid it (CCQ 2203 para 1, 2216 para 1, 2218) Note: One would still want a partnership agreement so as to delineate the roles of the partners and to perform a channeling function so that everyone knows what they are getting themselves into. Partnership Property Common Law o Defined as property brought into the partnership, property acquired on account of the firm, or 14 Tufo, Camion, Niziblian Summer 2010 property acquired for the purposes of and in the course of the partnership business (OPA s. 21). o Partnership property must be held and applied by the partners exclusively for the purposes of the partnership o Property bought with money belonging to the firm is deemed to be partnership property. Civil Law CCQ 2198. A partner is a debtor to the partnership for everything he promises to contribute to it. CCQ 2199. A contribution of property is made by transferring rights of ownership or of enjoyment and by placing the property at the disposal of the partnership. A contribution consisting in the enjoyment of property that would normally be required to be renewed during the term of the partnership transfers ownership of the property to the partnership, which becomes liable to return property of the same quantity, quality and value. CCQ 2200. A contribution consisting in knowledge or activities is owed continuously so long as the partner who undertook to make such a contribution is a member of the partnership; the partner is liable to the partnership for any profit he realizes from the contribution. CCQ 2208. Each partner may use the property of the partnership, provided he uses it in the interest of the partnership and according to its destination, and in such a way as not to prevent the other partners from using it as they are entitled. CCQ 2215. Each partner may compel the other partners to incur any expenses necessary for the preservation of the common property but one partner may not change the condition of that property without the consent of the others, regardless of how advantageous such changes may be. CCQ 2217. A partner without powers of management may not alienate or otherwise dispose of common property, subject to the rights of third persons in good faith. Note: Trust is not without its limits. It does not extend to the making of unilateral decisions. Day to Day Running of a Partnership Common Law OPA s. 24 o Partners share equally in capital, profits, and losses. Can be altered based on amount of investment brought in, expertise, labour/time investment o The firm must indemnify every partner for payments made and personal liabilities incurred in the ordinary and proper conduct of the business o Every partner may take part in the management of the business o Partners are not entitled to remuneration for working in the partnership business. o No new partner can be admitted to the partnership without the consent of all existing partners o Decisions on ordinary business matters are to be determined by a majority of the partners. However, no change in the nature of the partnership business is permitted without the consent of all existing partners o Partnership books are to be kept at the principal place of business and every partner may have access to the books to inspect or copy them. Civil Law o Partners share profits and losses equally if not fixed in the contract (CCQ 2202). Participation in the profits of a partnership entails the obligation to share in the losses (CCQ 2201). Partners cannot be excluded from participation in profits and cannot be exempt from sharing in losses vis-a-vis third 15 persons. (CCQ 2203) o All partners manage the business equally (CCQ 2215), but the partners may enter into agreements detailing their respective powers in the management of the affairs of the partnership (CCQ 2212) or can appoint someone, including a third person, to manage the partnership (CCQ 2213) (ex. in complicated family partnerships, the third person can step in to take the lead) o CCQ 2213. The manager, notwithstanding the opposition of the partners, may perform any act within his powers, provided he does not act fraudulently. The powers of management may not be revoked without a serious reason during the existence of the partnership, except where they were conferred by an act subsequent to the contract of partnership, in which case they may be revoked in the same manner as a simple mandate. o Unless otherwise stipulated, decisions are taken by the vote of a majority of the partners, regardless of the value of their interests in the partnership. However, decisions to amend the contract of partnership are taken by a unanimous vote. In addition, partners are entitled to participate in collective decisions (CCQ 2216), i.e. those that affect fundamental aspects of the business. o Any partner may inform himself of the affairs of the partnership and consult its books and records even if he is excluded from management (CCQ 2218) CCQ 2201. Participation in the profits of a partnership entails the obligation to share in the losses. CCQ 2202. The share of each partner in the assets, profits and losses is equal if it is not fixed in the contract. If the contract fixes the share of each partner in only the assets, profits or losses, it is presumed to fix the share for all three cases. CCQ 2203. Any stipulation whereby a partner is excluded from participation in the profits is without effect. Any stipulation whereby a partner is exempt from the obligation to share in the losses may not be set up against third persons. CCQ 2204. A partner may not compete with the partnership on his own account or on behalf of a third person or take part in an activity which deprives the partnership of the property, knowledge or activity he is bound to contribute to it; any profits arising from such competition belong to the partnership, without prejudice to any remedy it may pursue. CCQ 2205. A partner is entitled to recover the amount of the disbursements he has made on behalf of the partnership and to be indemnified for the obligations he has contracted or the losses he has suffered in acting for the partnership if he was in good faith. CCQ 2212. The partners may enter into such agreements between themselves as they consider appropriate with regard to their respective powers in the management of the affairs of the partnership. CCQ 2213. The partners may appoint one or more fellow partners or even a third person to manage the affairs of the partnership. The manager, notwithstanding the opposition of the partners, may perform any act within his powers, provided he does not act fraudulently. The powers of management may not be revoked without a serious reason during the existence of the partnership, except where they were conferred by an act subsequent to the contract of partnership, in which case they may be revoked in the same manner as a simple mandate. CCQ 2215. Failing any stipulation respecting the mode of management, the partners are deemed to have conferred the power to manage the affairs of the partnership on one another. Any act performed by a partner in respect of the common activities binds the other partners, without prejudice to their right to object, jointly or separately, to the act before it is performed. 16 Tufo, Camion, Niziblian Summer 2010 CCQ 2216. Every partner is entitled to participate in collective decisions, and he may not be prevented from exercising that right by the contract of partnership. Unless otherwise stipulated in the contract, decisions are taken by the vote of a majority of the partners, regardless of the value of their interests in the partnership. However, decisions to amend the contract of partnership are taken by a unanimous vote. CCQ 2217. A partner without powers of management may not alienate or otherwise dispose of common property, subject to the rights of third persons in good faith. CCQ 2218. Notwithstanding any stipulation to the contrary, any partner may inform himself of the affairs of the partnership and consult its books and records even if he is excluded from management. In exercising this right, the partner is bound not to impede the operations of the partnership unduly nor to prevent the other partners from exercising the same right. Removal of Partners Common Law o No majority of partners can expel any partner “unless a power to do so has been conferred by express agreement between the partners and (s. 25 OPA) Civil Law CCQ 2229. The partners may, by a majority vote, agree on the expulsion of a partner who fails to perform his obligations or hinders the carrying on of the activities of the partnership. A partner may, in similar circumstances, apply to the court for authorization to withdraw from the partnership; the court grants such a demand unless it considers it more appropriate to order the expulsion of the partner at fault. CCQ 2230. A partnership is dissolved by the causes of dissolution provided in the contract, by the accomplishment of its object or the impossibility of accomplishing it, or by consent of all the partners. It may also be dissolved by the court for a legitimate cause. CCQ 2231. Any partnership constituted for an agreed term may be continued by consent of all the partners. CCQ 2232. The uniting of all the shares in the hands of a single partner does not entail dissolution of the partnership, provided at least one other partner joins the partnership within 120 days. Note: No difference between removal and expulsion. If there are only two partners, majority may depend on the number of shares, contribution, etc. Or: get an arbitrator involved. Fiduciary Duties Common Law o Partners are bound to render true accounts and full information of all things affecting the partnership to any partner or the partner’s legal representatives (OPA s. 28) o Every partner must account to the firm for any benefit derived by the partner without the consent of the other partners from any transaction concerning the partnership or from any use by the partner of the partnership property, name or business connection (OPA s. 29(1)) Similar to prohibition of secret profits in agency. 17 o If a partner, without the consent of the other partners, carries on a business of the same nature as and competing with that of the firm, the partner must account for and pay over to the firm all profits made by the partner in that business (OPA s. 30) Duty of Loyalty Civil Law CCQ 2204. A partner may not compete with the partnership on his own account or on behalf of a third person or take part in an activity which deprives the partnership of the property, knowledge or activity he is bound to contribute to it; any profits arising from such competition belong to the partnership, without prejudice to any remedy it may pursue. [If you want to compete, simply disclose] Note: Same sort of duty that directors owe to corporations. Assignment of Partnership Interest Common Law o A partnership interest can be assigned, but this does not result in the assignee becoming a partner: (OPA s. 31) o An assignee of a partner is entitled to a share of the profits and a share of the partnership assets on dissolution. However, the assignee is not thereby entitled to participate in the management or administration of the partnership business. Civil Law CCQ 2209. A partner may associate a third person with himself in his share in the partnership without the consent of the other partners, but he may not make him a member of the partnership without their consent. Within 60 days after becoming aware that a person who is not a member of the partnership has acquired the share of a partner by onerous title, any partner may exclude the person from the partnership by reimbursing him for the price of the share and the expenses he has paid. This right lapses one year from the acquisition of the share. Note: Any liability of the assignee would not reflect on the partnership. Dissolution of the Partnership Common Law o By setting a fixed term (OPA s. 32(a)) o By specifying that the partnership will be dissolved at the end of a particular venture for which the partnership was created (OPA s. 32(b)) o By notice of the intention to dissolve (OPA s. 32(c)) o A partnership is dissolved automatically upon the death, bankruptcy, or dissolution of a partner (OPA s. 33(1)). This requires the remaining members to put together a new partnership if they wish to continue the business. Civil Law CCQ 2230. A partnership is dissolved by the causes of dissolution provided in the contract, by the accomplishment of its object or the impossibility of accomplishing it, or by consent of all the partners. It may also be dissolved by the court for a legitimate cause. CCQ 2258. A contract of undeclared partnership is terminated by consent of all the partners or by the expiry of its term or the fulfillment of the condition attached to the contract, by the accomplishment or impossibility of accomplishing the object of the contract. It is also terminated by the death or bankruptcy of one of the partners, by his being placed under protective 18 Tufo, Camion, Niziblian Summer 2010 supervision or by a judgment ordering the seizure of his share. o The death of a partner does not lead to the same outcome as in the common law, unless it is an undeclared partnership (but see exceptions under CCQ 2259) Liability of Partners in Contract Common Law o Every partner is an agent of the firm and of the other partners for the purpose of the business of the partnership, and the acts of every partner who does any act for carrying on in the usual way business of the kind carried on by the firm of which he or she is a member, bind the firm and the other partners unless the partner so acting has in fact no authority to act for the firm in the particular matter and the person with whom the partner is dealing either knows that the partner has no authority, or does not know or believe him or her to be a partner (s. 6 OPA) o An act or instrument relating to the business of the firm and done or executed in the firm name, or in any other manner showing an intention to bind the firm by a person thereto authorized, whether a partner or not, is binding on the firm and all the partners (s. 7 OPA) o If it is agreed between the partners to restrict the power of any one or more of them to bind the firm, no act done in contravention of the agreement is binding on the firm with respect to persons having notice of the agreement. (s. 9 OPA) o Every partner in a firm is liable jointly with the other partners for all debts and obligations of the firm incurred while the person is a partner, and after the partner’s death the partner’s estate is also severally liable (s. 10, OPA) Civil Law CCQ 2219. Each partner is a mandatary of the partnership in respect of third persons in good faith and binds the partnership for every act performed in its name in the ordinary course of its business. No stipulation to the contrary may be set up against third persons in good faith. CCQ 2220. An obligation contracted by a partner in his own name binds the partnership when it comes within the scope of the business of the partnership or when its object is property used by the partnership. A third person, however, may cumulate the defences which may be set up against the partner and the partnership and claim that he would not have entered into the contract if he had known that the partner was acting on behalf of the partnership. CCQ 2222. A person who gives reason to believe that he is a partner, although he is not, may be held liable as a partner towards third persons in good faith acting in that belief. The partnership is not liable towards third persons, however, unless it gave reason to believe that such person was a partner and it failed to take measures to prevent third persons from being mistaken in circumstances that made such a mistake predictable. CCQ 2223. Silent partners are liable towards third persons for the same obligations as declared partners. CCQ 2224. A partnership may not make a distribution of securities to the public or issue negotiable instruments, on pain of nullity of the contracts entered into or of the securities or instruments issued and of the obligation to compensate for any injury it causes to third persons in good faith. In such a case, the partners are solidarily liable for the obligations of the partnership. CCQ 2225. A partnership may sue and be sued in a civil action under the name it declares. Liability for Tort Common Law 19 OPA 11. Where by any wrongful act or omission of a partner acting in the ordinary course of the business of the firm, or with the authority of the co-partners, loss or injury is caused to a person not being a partner of the firm, or any penalty is incurred, the firm is liable therefor to the same extent as the partner so acting or omitting to act. OPA 12. In the following cases, namely, (a) where one partner, acting within the scope of the partner’s apparent authority, receives the money or property of a third person and misapplies it; and (b) where a firm in the course of its business receives money or property of a third person, and the money or property so received is misapplied by one or more of the partners while it is in the custody of the firm, the firm is liable to make good the loss. This liability is joint and several CCQ 2221. In respect of third persons, the partners are jointly liable for the obligations contracted by the partnership but they are solidarily liable if the obligations have been contracted for the service or operation of an enterprise of the partnership. Limited Partnerships There has to be one general partner. o Why have limited partnerships? - Aimed at shifting the default rule from personal liability to limited liability with notice to creditors o Limited partners: - Cannot be involved in management of the partnership - May not be directly liable for torts committed in carrying on the business - May be vicariously liable for the acts of agents or employees engaged in carrying on the business (but again limited to the amount of one’s investment). o The limit of their liability is the amount of their investment. See LPA 2, 7-13 See CCQ 2236-2249. Limited Liability Partnerships (LLPs/CMN) / Joint Stock Companies (CVL) There does not need to be a general partner. Why should partners who are not involved in a negligent act be personally exposed to liability arising from the activities of their negligent partners? Why must traditional professions such as law, accounting and medicine continue to face exposure to personal liability for the activities of their negligent partners while other professionals can limit their exposure through incorporation or some other limited liability structure? o LLPs adopted in Ontario in 1998 o Found in the Professional Code of Quebec, s. 187.11-187.20 - Governed by the rules concerning general partnerships contained in the Civil Code - Must self-designate as LLP Common Law See OPA 44.1 – 44.3 Civil Law 187.14. (Professional Code): A member of an order carrying on his or her professional activities within a limited liability partnership is not personally liable for obligations of the partnership or of any other professional arising from fault on the part of the other professional or the other professional's servant or mandatary in the course of their professional activities within the partnership. 20 Tufo, Camion, Niziblian Summer 2010 See Professional Code of Quebec 187.11-187.16 Question: Why not simply allow incorporation? IV. INTRODUCTION TO THE CORPORATION Function and Place of the Corporation in Society o Who should decide corporate policy? o How should decision makers be chosen? o What matters or interests ought to be considered in making corporate decisions? o If the matters or interests that are required to be considered conflict, how and by whom should the conflict be resolved? o What are the appropriate methods of accountability for corporate decisions and what are the grounds on which decisions can be reviewed and overturned? o Corporate law is about designing the rules for organizing the collective efforts of the participants in the enterprise I. Wealth Maximization Theory Law and Economics (Richard Posner 2007): The economic analysis of law tries to explain and predict the behavior of participants in and persons regulated by the law. It also tries to improve law by pointing out ways in which existing or proposed laws have unintended or undesirable consequences on economic efficiency, the distribution of income and wealth, or other values. The basis of the theory is walth maximization as the rationale for using the corporation as a vehicle for economic activity. Its normative basis is utilitarianism. The free market is paradigmatic of how utility is promoted non-coercively by utility- seeking individuals. Institutions should facilitate, or where that is infeasible approximate, the operations of a free market and thus maximize autonomous, utility-seeking behaviour. Because utility seeking in a market requires inducing others to enter into transactions advantageous to them, wealth is automatically transferred to those who have productive assets, whether goods or time. By the same token, those who have no productive assets have no ethical claim on the assets of others. Problems: The market is not perfect, nor does it have perfect information. Players are not equal. The Nexus of Contracts (William Bratton 1989) o o Corporation exists to maximize the wealth of shareholders and corporate management ought to act as the SHs’ agent in pursuing that end. o The neoclassical variant’s central point is that the firm is a legal fiction that serves as a nexus for a set of contracting relations among individual factors of production o The model of the corporation is drawn from the parties and terms for their firm of contracts o Economists rely on basic assumptions about the behaviour of marketplace actors and the nature of marketplace contracts. The actors are rational economic actors—self-interested individuals with divergent interests o A corporation exists to maximize the wealth of its shareholders, and the corporation’s management ought to act as the shareholders’ economic agent in pursuing this end. The ability of employees, suppliers, and customers to control corporate management’s decisions will be set by the terms of their contracts with the other parties in the nexus of contracts that is the corporation o Limited role for corporate law: it does not invest and legitimize power in hierarchical superiors but appears as just another term of the contract governing equity capital input. Since the fittest arrangements survive, the contract effects an optimal sharing of risk. o No basis for intervention by government for the protection of shareholders Customers 21 Banks The Corporation Creditors Employees Problems: - Directors’ power to bypass shareholders - Where are the shareholders in this theory? They rely on implicit contracts because they receive the residual interest of the corporation (But why is the shareholders’ contract implicit? They’ve bought shares in the company and that is a contract!) - This model does not take into account the context in which the corporation operates (community, environment, etc.) - This model also assumes that everyone is on an even playing field, which is simply not the case. II. Team Production Theory/Corporation as Mediating Hierarchy (Blair and Stout 1999) o Assigning control rights not to shareholders, nor to any other stakeholder in the firm, but to a third party—the board of directors—which is largely insulated from the direct control of any of the various economic interests that constitute the corporation. o An essential but generally overlooked “contract” fundamental to the nature of public corporations is the “pactum subjectionis” under which shareholders, managers, employees, and other groups that make firm-specific investments yield control over both those investments and the resulting output to the corporation’s internal governing hierarchy o The directors are “mediating hierarchs” o Corporate law is designed to protect the corporate coalition by allowing directors to consider the interests of a variety of stakeholders o The mediating hierarchy accounts for (and supports) shareholders’ limited voting rights, and suggests that shareholders should be allowed to sue directors only when this serves the interest of the corporation as a whole, rather than serving shareholders’ interests at the expense of other stakeholders o The corporation has a fundamentally political nature o How to explain emphasis on shareholders? Corporate directors enjoy considerable discretion in terms of who receives what portion of the economic surplus resulting from team production. The minimum demands of each team member must be met, but nothing more. The returns to any particular corporate stakeholder will be determined not only by market but also by political forces (rise of institutional investors/decline of labor unions has tipped the balance in favor of SH OR globalization has exerted downward pressure on US wages while investors can seek opportunities abroad = SH have more bargaining power and the adjustment is necessary to keep the coaltion together) Note: Profit is not necessarily the overriding concern here. Problems: o Model ignores agency costs (directors may simply pursue their own interests) o Under Canadian law, fiduciary duties can be owed to other stakeholders, not only the shareholders (i.e. directors can really do whatever they want and the agency costs can be enormous). Under US law, only the shareholders can bring action and the fiduciary is owed only to them. o Only shareholders can vote the directors in and out A duty to a range of stakeholders is meaningless unless stakeholders have some way of enforcing that duty. III. The Corporation as a Public Institution o Greenfield argues against the idea that corporate law, because it is contract law, is private and that it should be shielded from the political and legal processes. Corporate law should be a source of public policy initiatives o Contract and property law are no more neutral, private, or pre-legal than statutory law. Contract and property rights are correctly seen as essential to economic development and, in many respects, to social justice. These rights are not best perceived as natural, pre-legal, or non-political, but rather should be 22 Tufo, Camion, Niziblian Summer 2010 seen as tools to be utilized in furtherance of social good. Applied to the setting of corporate law, the language of rights may be used as a descriptive matter but is out of place in a normative discussion. Greenfield’s New Principles of Corporate Law 1) The ultimate purpose of corporations should be to serve the interests of society as a whole: a company cannot be considered a success if the total social value it creates is less than the social costs it throws off 2) Corporations are distinctively able to contribute to the societal good by creating financial prosperity 3) Corporate law should further principles one and two or else a small group of elites will reap the benefits 4) A corporation’s wealth should be shared fairly among those who contribute to its creation (equity investors, debt creditors, consumers, government, labor – would increase behavior beneficial to firm) 5) Participatory, democratic corporate governance is the best way to ensure the sustainable creation and equitable distribution of corporate wealth: a. To make possible for a corporation to serve its stakeholders by creating wealth in a sustainable way and then equitably share that wealth, the management of the firm needs to be subject to different constraints than at present. These changes are simple, yet profound. b. For example, directors need to be held to a fiduciary obligation to all the firm’s stakeholders. Allow non-shareholder stakeholders to bring suits in court for violations of the duties of care and loyalty, and providing some mechanism for non-shareholder stakeholders to elect their own representatives to the board Note: In Germany, all stakeholders sit at the table. Some believe that this model reduces transaction costs. Scope of the Discretionary Decision Making of Directors (People’s) o Insofar as the statutory fiduciary duty is concerned, it is clear that the phrase the “best interests of the corporation” should be read not simply as the “best interests of the shareholders.” o From an economic perspective, the “best interests of the corporation” means the maximization of the value of the corporation o In determining whether directors are acting with a view to the best interests of the corporation it may be legitimate, given all the circumstances of a given case, for the board to consider, inter alia, the interests of shareholders, employees, suppliers, creditors, consumers, governments and the environment. V. THE CORPORATION AS A LEGAL PERSON Salomon v. Salomon & Co. Ltd (1896) Jurisdiction UK (HL) Facts Salomon was a leather merchant and boot manufacturer. Together with his wife, four sons, and a daughter, he formed a limited company under the English Companies Act. Under the company’s articles of association, the company had capital of 40,000 shares, with each share having a value of L1. In return for selling his business to the new company at a price of L38000, Salomon was to be issued 20,000 shares and a payment of L16000 in cash or debentures. The Companies Act required that each company have seven shareholders. Salomon’s wife, sons, and daughter each held one share, and he the rest. The company eventually failed and was wound up. It turned out that if the money obtained from the sale of the company’s remaining assets was to be applied to the payment of Solomon’s debentures, nothing would be left for the other creditors. The liquidator of the company claimed that the company was merely an agent or alias of Solomon, that Salomon should be personally liable to the other creditors, and that no payment should be made on his debentures until these creditors were paid. Issues Is the company Salomon in another form? Holding No, it is a corporation. Ratio - Salomon wanted to extend his business and make provisions for his family. Not unusual. 23 - Salomon had met the requirements of the Companies Act: the memorandum of association was signed by seven shareholders. The Act says nothing about them having to have no connection with one another or having to have a mind and will of their own. - The company is a different person from the subscribers to the memorandum, even though the business and managers remain the same, and the same hands receive the profit. - A company can raise money on debentures, which an ordinary trader cannot do. Any member of the company acting in good faith is as much entitled to take and hold the company’s debentures as any outside creditor. - The motives of those who incorporated the company are irrelevant to the company’s rights and liabilities as a separate legal person. - The fact that a company carries on on behalf of its shareholders does not create a principal/agent relationship - The creditors were aware of the incorporation of the company but did not take measures to protect themselves. Too bad for them. Comments Was it fair for Solomon to both make himself a priority creditor AND to protect his personal assets by means of incorporation? Yes. Unlike corporations, partnerships do not have a legal existence separate from their owners, and general partners have personal liability for firm debts. What is the rationale for corporations to have a separate legal personality and limited liability? Corporations can sue and be sued. Can sign contracts & enter into transactions. Can hold property. Separate Legal Personality and Limited Liability of Shareholders Common Law (CBCA) Capacity of a corporation o 15(1) A corporation has the capacity and, subject to this Act, the rights, powers and privileges of a natural person. Shareholder immunity o 45(1) The shareholders of a corporation are not, as shareholders, liable for any liability, act or default of the corporation except under subsection 38(4), 118(4) or (5), 146(5) or 226(4) or (5). Civil Law QCA 41. The shareholders of the company shall not, as such, be responsible for any act, default or liability of the company, or for any engagement, claim, payment, loss, injury, transaction, matter or thing relating to or connected with the company, beyond the amount unpaid on their respective shares in the capital stock thereof. QCA 123.16. From the date indicated in the certificate of constitution, the company is a legal person. QCA 123.29. A company has the full enjoyment of civil rights in Québec and outside Québec, except respecting what is proper to the human person and subject to the laws applicable in any particular case. QBCA 10. A corporation is constituted as of the date and, if applicable, the time shown on the certificate of constitution issued by the enterprise registrar in accordance with Chapter XVIII. The CORPORATION is a LEGAL PERSON as of that time. QBCA 224. Shareholders are not, as shareholders, liable for any act of the corporation. 24 Tufo, Camion, Niziblian Summer 2010 HOWEVER, they are DEBTORS to the corporation for any UNPAID AMOUNT ON SHARES THEY HOLD in its share capital. CCQ 301. Legal persons have full enjoyment of civil rights. CCQ 303. Legal persons have capacity to exercise all their rights, and the provisions of this Code respecting the exercise of civil rights by natural persons are applicable to them, adapted as required. They have no incapacities other than those which may result from their nature or from an express provision of law. CCQ 304. Legal persons may not exercise tutorship or curatorship to a person. They may, however, to the extent that they are authorized by law to act as such, hold office as tutor or curator to property, liquidator of a succession, sequestrator, trustee or administrator of another legal person. CCQ 309. Legal persons are distinct from their members. Their acts bind none but themselves, except as provided by law. CCQ 314. A legal person exists in perpetuity unless otherwise provided by law or its constituting act. CCQ 317. In no case may a legal person set up juridical personality against a person in good faith if it is set up to dissemble fraud, abuse of right or contravention of a rule of public order. Questions There is a great deal of discussion in Salomon about the “one-man company.” The English Companies Act of 1862 contained a requirement that a company have at least seven shareholders. What was the rationale for that requirement? The CBCA contains no such requirement. Part of the consideration Salomon received on incorporation was an issue of £10,000 in debentures. A debenture is evidence of indebtedness, like a promissory note. Debentures are often secured with an interest in a company’s assets, or collateral. In Salomon, the debentures were pledged as security for an advance of £5,000, so that they were still valuable to Salomon to the extent that the business even in bankruptcy was nevertheless worth more than that amount. Should Salomon have been able to protect his own investment this way while shielding himself from the claims of other creditors because of the limited liability of the corporation? What do you think about Lord Macnaghten’s statement that “[t]he unsecured creditors of Salomon & Co, Ltd may be entitled to sympathy, but they have only themselves to blame for their misfortunes. They had fair notice that they were no longer dealing with an individual, and must be taken to have been cognizant of the memorandum and of the articles of association”? If the corporate form permits limited liability, what should a creditor do to try to protect his or her interest? Should government protect creditors? How? Consequences of Incorporation and Separate Legal Identity Consequences that flow from the conception of the corporation as a separate legal personality include: a) limited liability, b) perpetual succession of a corporation, c) the distinction between a corporation and its controlling shareholders, and d) separate ownership by the corporation of its own property. Lee v. Lee’s Air Farming Ltd. (1961) Jurisdiction New Zeland / PC Facts Lee formed Lee’s Air Farming Ltd. for the purpose of carrying on the business of aerial top- dressing. He held 2,999 of the company’s 3,000 shares. He was the company’s sole director, officer, and manager. He was also employed as the company’s chief pilot at a salary he arranged. He was killed in a flight accident. His widow claimed compensation under the NZ Workers’ Compensation Act according to which an employer is liable to pay compensation if a worker suffered injury in the course of employment. 25 Issues Was Lee a worker? Holding Yes. Ratio - The aerial operations were performed because Lee had been in a contractual relationship with the company. Lee was one legal person who made a contract with the company as another legal person. - The company was not a sham or a simulacrum. It was a proper legal person. - The fact that Lee was the company’s agent in the negotiation of the employment contract is not a problem - One person may function in dual capacities as per Solomon. - It was not Lee who was giving himself orders whilst an employee, it was the company who gave the orders. Macaura v. Northern Assurance Co Ltd. (1952) Jurisdiction UK (HL) Facts The appellant was the owner of an estate, the respondents were five insurance companies with whom he contracted insurance against fire on timber which he kept on the estate. The appellant had assigned all of the timber to a company: Irish Canadian Saw Mills Ltd. The company paid L42000for the timber and issued the appellant with 42,000 shares at L1 per share. No further shares were ever issued. The timber was destroyed by fire and the appellant sought the insurance payment. Issues Did the appellant have any insurable interest in the goods subject to the insurance policies? Were the respondents at liberty to raise the contention that he held no such interest? Holding No. Yes. Ratio The appellant could only have insured as a creditor or shareholder of the company, but neither of these avenues is available: no creditor can ensure the furniture of his debtor, and no shareholder has any right to property belonging to the company. Neither a simple creditor nor a shareholder has any insurable interest in a particular asset which the company holds. Kosmopoulos v. Constitution Insurance Co. (1987) Jurisdiction SCC Facts Kosmopoulos entered into a lease for premises in Toronto. From there he operated a businesses under the name of Spring Leather Goods. It was carried on as a sole proprietorship and eventually incorporated. K, however, continued to think that he owned the store and its assets. Documentation pertaining to the business made no reference to the company but only to “K carrying on as SLG.” The lease also remained in his name. K went on to obtain insurance for the contents of the business premises. Even though the insurer knew that the insurance was intended for the company, the insured was described as “K operating as SLG” on the policy. Naturally, a fire broke out causing damage to the assets and premises. K sought the insurance payment and the insurance company refused to pay him saying he had no legal or equitable interest in the company’s assets. K claims that the corporate veil should be lifted as, when this is done, it becomes clear that that the company’s property was K’s property. Issues Should the corporate veil be lifted? Holding Yes. Ratio - The separate entities principle is not enforced when it would yield a result too flagrantly opposed to justice. - Wilson J expands the concept of insurable interest: K, as sole shareholder of the company, was so placed with respect to the assets of the business as to have benefit from their existence and prejudice from their destruction. He therefore had an insurable interest in them capable of supporting the insurance policy. - McIntyre J does not agree to overly expand the concept of insurable interest. Instead, he notes that modern company law now permits the creation of companies with one shareholder, so that the identity between the company and the sole shareholder and director is such that an insurable interest in the company’s assets may be found in the sole shareholder. 26 Tufo, Camion, Niziblian Summer 2010 Comments “The doctrine laid down in Salomon v. Salomon & Co. … has to be watched very carefully. It has often been supposed to cast a veil over the personality of a limited company through which the courts cannot see. But that is not true. The courts can and often do draw aside the veil. They can, and often do, pull off the mask. They look to see what really lies behind.” Where Courts Have Disregarded the Separate Legal Personhood of the Corporation o Cases that involve allegations of fraudulent conduct or objectionable purpose on the part of a company’s principals o Cases where a company existed as a “shell” and was clearly undercapitalized to meet its reasonable financial needs o Cases that involve tort claims against the company, particularly those where a director, shareholder, or employee has committed an intentional tort, or the tort of inducing breach of contract o Cases where the company was not incorporated for bona fide business reasons but for other purposes, often to avoid taxation o Cases that involve non-arm’s-length transactions between parent and subsidiary companies; and o Cases where courts determine that equity or the interests of justice are better served by disregarding the corporate form Big Bend Hotel v. Security Mutual Casualty Co. (1980) Jurisdiction British Columbia (SC) Facts Kumar was the president and sole shareholder of BB Hotel. He previously operated and was the sole shareholder of another hotel which was destroyed by fire. There were some suspicions of arson at the time, possibly involving Kumar. When Kumar purchased the insurance policy for BB Hotel, he did not disclose this information. BB Hotel was destroyed in a fire. Kumar claimed that as BB was a separate legal entity from himself and the company he previously operated, he could not have been expected to disclose the previous losses - and that the corporate veil should not be lifted. Issues Should the corporate veil be lifted? Holding Yes. Ratio - It is obvious that Kumar did not disclose the previous loss because he knew that he would have trouble obtaining an insurance policy for BB. - Kumar was aware of the materiality of the information he concealed. - Courts have previously lifted the corporate veil in cases of fraud and improper conduct of individual company members. - Equity will not allow an individual to use a company as a shield for improper conduct or fraud. Questions o Was it necessary to lift the veil in order to reach this result? Was the failure to disclose itself not a “material misrepresentation” sufficient to void the claim for insurance? o Why should the insurance company not be responsible for making further inquiries into the relevant history? Who should bear the risk of limited liability? Parent-Subsidiary An exception to the Salomon principle arises where the corporation is simply an agent of the shareholder: (Smith, Stone and Knight Ltd. v. Birmingham Corporation): - Were the profits treated as profits of the parent company? - Were the persons conducting the business appointed by the parent company? - Was the parent company the head and brain of the trading venture? - Did the parent company govern the trading venture, decide what should be done, and what capital should be embarked on the venture? - Did the parent company make profits by its skill and direction? - Was the parent company in effectual and constant control? The difficulty with these tests is that the answers are positive in virtually every parent–subsidiary company 27 relationship. Yet the corporate entity of subsidiaries is not disregarded in every affiliated company case. Generally, a subsidiary, even a wholly owned subsidiary, will not be found to be the alter ego of its parent unless the subsidiary is under the complete control of the parent and is nothing more than a conduit used by the parent to avoid liability. The alter ego principle is applied to prevent conduct akin to fraud that would otherwise unjustly deprive claimants of their rights. Walkovszky v. Carlton (1966) Jurisdiction NYCA Facts The plaintiff was injured by a cab owned by the Seon Cab Corporation. The defendant, Carlton, was a stockholder of ten corporations, including Seon, each of which had two cabs insured by the minimum auto liability insurance required by law ($10,000). Although seemingly independent of one another, the corporations were alleged to have operated as a single entity with regard to financing, supplies, repairs, employees, and garaging, and all were named as defendants. The plaintiff asserted that he was also entitled to hold their stock holders personally liable for the damages sought because the multiple corporate structure constituted an unlawflul attempt to defraud members of the public who might be injured by the cabs. Issues Should the corporate veil be pierced? / Can the defendant Carlton be held personally liable? Holding No. No. Ratio - Courts will pierce the corporate veil whenever necessary to prevent fraud or achieve equity. - Liability should be extended to reach assets beyond those belonging to the corporation, only when one uses control of the corporation to further his own rather than the corporation’s business. Such liability extends not only to the corporation’s commercial dealings but to its negligent acts as well. - In this case, it is one thing to assert that a corporation is a fragment of a larger corporate combine which actually conducts the business, and another to claim that the corporation is a dummy for its individual stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends. - Either circumstance would justify piercing the corporate veil but with different results. - In the first case, only the larger corporate entity would be held financially responsible. - In the second case, the stockholder would be personally liable. - The corporate form may not be disregarded merely because the assets of the corporation together with the mandatory insurance coverage of the vehicle are insufficient to assure the recovery sought. If Carlton were to held individually liable on those facts alone, the decision would apply to all cabs owned by their individual drivers who conduct business through corporations and carry the minimum insurance required. - If the insurance coverage required by statute is inadequate for the protection of the public, the remedy lies not with the courts but with the Legislature. - The principle relied upon to sustain the imposition of personal liability is fraud. Such a cause of action cannot withstand analysis. If it is not fraudulent for the owner-operator of a single cab corporation to take out only the minimum required liability insurance, the enterprise does not become illicit or fraudulent merely because it consists of many such corporations. Whatever rights the plaintiff may be able to assert against parties other than the registered owner of the vehicle come into being not because he has been defrauded but because, under the principle of Respondent superior, he is entitled to hold the whole enterprise responsible for the acts of its agents. The complaint falls short of adequately stating a cause of action against the defendant Carlton in his individual capacity. Dissent: - The corporations were intentionally undercapitalized for the purpose of avoiding responsibility for acts which were bound to arise - The issue is whether the policy which affords those desiring to engage in a business enterprise the privilege of limited liability through the use of the corporate device, is so 28 Tufo, Camion, Niziblian Summer 2010 strong that it will permit that privilege to continue no matter how much it is abused. - If a corporation is organized and carries on a business without substantial capital to meet its debts, it is inequitable that shareholders should set up such a flimsy organization to escape personal liability. - It could not have been intended to shield those individuals who organized corporations with the specific intent of avoiding responsibility to the public when the operation of the enterprise yielded profits sufficient to purchase additional insurance. - It is reasonable to assume that the Legislature believed that those individuals and corporations having substantial assets would take out insurance in excess of the minimum in order to protect those assets from depletion - A shareholder of a corporation vested with a public interest, organized with capital insufficient to meet liabilities which are certain to arise in the ordinary course of the corporation’s business, may be held personally responsible for such liabilities. VI. DIRECTORS AND OFFICERS The General Structure of a Corporation QuickTime™ and a decompressor are neede d to see this picture. Role of Directors o Subject to any unanimous shareholder agreement (can take place after formation of corporation), the directors shall manage, or supervise the management of, the business and affairs of a corporation. - CBCA s. 102(1), QBCA s. 112, Common Law CBCA 102(1) (1) Subject to any unanimous shareholder agreement, the DIRECTORS shall manage, or supervise the management of, the business and affairs of a corporation. Number of directors (2) A corporation shall have one or more directors but a distributing corporation, any of the issued securities of which remain outstanding and are held by more than one person, shall have not fewer than three directors, at least two of whom are not officers or employees of the corporation or its affiliates. CBCA 103. (1) Unless the articles, by-laws or a unanimous shareholder agreement otherwise provide, the directors may, 29 by resolution, make, amend or repeal any by-laws that regulate the business or affairs of the corporation. Shareholder approval (2) The directors shall submit a by-law, or an amendment or a repeal of a by-law, made under subsection (1) to the shareholders at the next meeting of shareholders, and the shareholders may, by ordinary resolution, confirm, reject or amend the by-law, amendment or repeal. Effective date (3) A by-law, or an amendment or a repeal of a by-law, is effective from the date of the resolution of the directors under subsection (1) until it is confirmed, confirmed as amended or rejected by the shareholders under subsection (2) or until it ceases to be effective under subsection (4) and, where the by-law is confirmed or confirmed as amended, it continues in effect in the form in which it was so confirmed. Idem (4) If a by-law, an amendment or a repeal is rejected by the shareholders, or if the directors do not submit a by-law, an amendment or a repeal to the shareholders as required under subsection (2), the by-law, amendment or repeal CBCA 121. Subject to the articles, the by-laws or any unanimous shareholder agreement, (a) the directors may designate the offices of the corporation, appoint as officers persons of full capacity, specify their duties and delegate to them powers to manage the business and affairs of the corporation, except powers to do anything referred to in subsection 115(3); (b) a director may be appointed to any office of the corporation; and (c) two or more offices of the corporation may be held by the same person. CBCA 146 (1) An otherwise lawful written agreement among all the shareholders of a corporation, or among all the shareholders and one or more persons who are not shareholders, that RESTRICTS, in whole or in part, the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation is VALID. Declaration by single shareholder (2) If a person who is the beneficial owner of all the issued shares of a corporation makes a written declaration that restricts in whole or in part the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation, the declaration is deemed to be a unanimous shareholder agreement. Constructive party (3) A purchaser or transferee of shares subject to a unanimous shareholder agreement is deemed to be a party to the agreement. When no notice given (4) If notice is not given to a purchaser or transferee of the existence of a unanimous shareholder agreement, in the manner referred to in subsection 49(8) or otherwise, the purchaser or transferee may, no later than 30 days after they become aware of the existence of the unanimous shareholder agreement, rescind the transaction by which they acquired the shares. Rights of shareholder (5) To the extent that a unanimous shareholder agreement restricts the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation, parties to the unanimous shareholder agreement who are given that power to manage or supervise the management of the business and affairs of the corporation have all the rights, powers, duties and liabilities of a director of the corporation, whether they arise under this Act or otherwise, including any defences available to the directors, and the directors are relieved of their rights, powers, duties and liabilities, including their liabilities under section 119, to the same extent. Discretion of shareholders (6) Nothing in this section prevents shareholders from fettering their discretion when exercising the powers of directors under a unanimous shareholder agreement. Civil Law CCQ 334. Legal persons assuming a juridical form governed by another title of this Code are subject to the rules of this chapter; the same applies to any other legal person if the Act by which it is constituted or which applies to it so provides or indicates no other rules of functioning, dissolution or liquidation. 30 Tufo, Camion, Niziblian Summer 2010 They may, however, make DEROGATIONS in their by-laws from the rules concerning their functioning, PROVIDED the rights of the members are safeguarded. CCQ 335. The board of directors manages the affairs of the legal person and exercises all the powers necessary for that purpose; it may create management positions and other organs, and delegate the exercise of certain powers to the holders of those positions and to those organs. The board of directors adopts and implements management by-laws, subject to approval by the members at the next general meeting. QCA 123.72. The affairs of a company shall be managed by a board of one or more directors. However, the affairs of a company that has made a distribution to the public of its securities shall be managed by a board of not fewer than three directors. QCA 123.91. The SHAREHOLDERS, if ALL OF THEM CONSENT thereto and make a WRITTEN AGREEMENT to that effect, may RESTRICT THE POWERS OF THE DIRECTORS. Sole shareholder. The sole shareholder may also restrict the powers of the directors if he makes a written statement to that effect. QBCA 112. Subject to a unanimous shareholder agreement, the board of DIRECTORS exercises ALL THE POWERS NECESSARY to MANAGE, or SUPERVISE the MANAGEMENT of, the business and affairs of the corporation. Except to the extent provided by law, such powers may be exercised without shareholder approval and may be delegated to a director, an officer or one or more committees of the board. QBCA 213. All the shareholders of a corporation, whether or not their shares carry voting rights, may agree in writing among themselves or among themselves and one or more third persons to restrict the powers of the board of directors to manage, or supervise the management of, the business and affairs of the corporation, or to withdraw all such powers from the board. A sole shareholder may make a written declaration that restricts the powers of the board of directors or withdraws all powers from the board. The declaration is equivalent to a unanimous shareholder agreement. Note: Shareholders can be directors and vice-versa. Senior managers can have the same responsibilities as directors. Some directors can also be senior managers. Directors may or may not be employees of the corporation. What Do Directors Really Do? Directors appoint the officers or just the senior officers. o Myles Mace Directors do not manage the corporation, don’t have much of a role in setting corporate strategy or in monitoring the performance of the management, but can discipline the president and give him/her useful advice. o Conference Bd of Cda - Management often controls the board rather than the other way around and the board’s effectiveness is often a function of the president’s desire for or tolerance of its informed input. - Boards are excessively hesitant to fire top management (who will fill the gap and when?) Director Obligations o Directors owe fiduciary obligations and a duty of care (to whom?) o Directors are AGENTS and must put the interests of the corporation first. Peoples Department Stores Inc. V. Wise (2004) Jurisdiction SCC Facts In the context of determing an insolvency law question, the SCC discussed the scope of duties of directors and officers both for the financially healthy and distressed corporation. 31 Issues To whom do the directors and officers owe a fiduciary obligation? Holding To the corporation, and not merely the shareholders. From an economic perspective, the best interests of the corporation means the maximization of the value of the corporation. Ratio - CBCA 122(1) (a): The fiduciary duty: requires directors and officers to act honestly and in good faith with a view to the best interests of the corporation. - CBCA 122(1) (b): The duty of care: imposes a legal obligation upon directors and officers to be diligent in supervising and managing the corporation’s affairs. The Statutory Fiduciary Duty - Directors and officers must avoid conflicts of interest with the corporation. They must avoid abusing their position to gain personal benefit. They must maintain the confidentiality of information they acquire by virtue of their position. - There may be situations where a profit must be disgorged although not gained at the expense of the company, on the grounds that a director must not be allowed to use his position to make a profit even if it was not open to the company to participate in the transaction. - Liability to account does not depend on proof of an actual conflict of duty and self- interest. - However, it is not required that directors and officers in all cases avoid personal gain as a direct or indirect result of their honest and good faith supervision or management of the corporation. In many cases, the interests of directors and officers will innocently coincide with those of the corporation, especially if they are also shareholders. - In so far as the statutory fiduciary duty is concerned, the phrase “the best interests of the corporation” should be read not simply as the best interests of shareholders. - Various other factors may be relevant in what directors should consider in soundly managing with a view to the best interests of the corporation. - This includes employees, the community, shareholders, suppliers, creditors, consumers, governments, and the environment - In resolving competing interests, it is incumbent upon the directors to act honestly and in good faith with a view to the best interests of the corporation - In assessing the actions of directors, it is evident that any honest and good faith attempt to redress the corporation’s financial problems will, if successful, both retain value for shareholders and improve the position of creditors. If unsuccessful, it will not qualify as a breach of the statutory fiduciary duty. - The fact that creditors’ interests increase in relevance as a corporation’s finances deteriorate is relevant to the exercise of discretion by a court in granting standing to a party as a complainant under s.238(d) of the CBCA as a “proper person” to bring a derivative action in the name of the corporation under ss. 239 and 240 of the CBCA, or to bring an oppression remedy claim under s.241 of the CBCA. The Statutory Duty of Care - Three elements of art. 1457 of the CCQ are relevant to the integration of the director’s duty of care into the principles of extra-contractual liability: who has the duty (every person), to whom is the duty owed (another), and what breach might trigger liability (rules of conduct). - Directors and officers come within the expression “every person” - The word “another” can include creditors. - The interpretation can be harmoniously integrated with the wording of the CBCA. Unlike the statement of the fiduciary duty which specifies that directors and officers must act with a view to the best interests of the corporation, the statement of the duty of care does not refer to an identifiable party as the beneficiary of the duty. Instead, it provides that every director and officer shall exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. - If a breach of the standard of care, causation, and damages are established, creditors can resort to 1457 to have their rights vindicated. - S. 122(1)(b) requires more of directors and officers than the traditional common law duty 32 Tufo, Camion, Niziblian Summer 2010 of care. It is an objective standard, which means that the factual circumstances surrounding the actions of the director or officer are relevant (contextual approach), while their subjective motivations pertain to the statutory fiduciary duty. The Business Judgment Rule - It might be tempting for some to see unsuccessful business decisions as unreasonable or imprudent in retrospect. Because of this risk of hindsight bias, Canadian courts have developed a rule of deference to business decisions: the Business Judgment Rule. - The court looks to see that the directors made a reasonable decision, not a perfect one. - Decisions must be reasonable in light of all the circumstances about which the directors and officers knew or ought to have known - In order for a plaintiff to succeed in challenging a business decision, he has to prove that the directors acted a) in breach of the duty of care and b) in a way that caused injury to the plaintiff Comments Choudhury: The extra-contractual duty of care should not be applied to the duty of care in corporate law. There is no gap in the CBCA here AND we are not dealing with a provincially incorporated company. In corporate law, the duty of care simply entails following certain processes in reaching decisions. Therefore, the duty of care is owed exclusively to shareholders. (Ontario has changed its relevant legislation to reflect this: art. 14 of the OBCA). According to the SCC, the duty of care is now owed to everyone (customers, creditors, shareholders, environment, etc.). CBCA 122(1) Every director and officer of a corporation in exercising their powers and discharging their duties shall: a) Act honestly and in good faith with a view to the best interests of the corporation; and b) Exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. o The first duty has been referred to as the “fiduciary duty.” It is better described as the “duty of loyalty.” o The second duty is commonly referred to as the “duty of care.” Generally speaking, it imposes a legal obligation upon directors and officers to be diligent in supervising and managing the corporation’s affairs. Nielsen Estate v. Epton (2006) Jurisdiction Alberta QB Facts A corporate employee, Nielsen, was killed while operating a hoist to lift a spreader beam at the shop of his employer, Fabtec. The beam was designed in a manner in which it could not safely latch onto the type of hoist used, and the beam fell and struck Nielsen. Epton, Fabtec’s president had previously issued specific instructions to Fabtec’s onsite supervisor to install the beam. The company did not have a safety policy with regard to operating the hoist. Nielsen’s estate sought to hold Epton personally liable in negligence for acts and omissions in his capacity as director. Epton had not purchased coverage for himself as a director under Alberta’s Workers’ Compensation Act. Issues Does a corporate director owe a duty of care to corporate employees? Holding Yes. Ratio - The fact that the Workers’ Compensation Act provides for a scheme whereby directors can purchase coverage indicates that the Legislature contemplated that there would be cases in which there would or should be director liability personally to employees - The Legislature also addressed director liability respecting worker safety under the Occupational Health and Safety Act. - There is a duty on the part of directors to take such measures as are reasonably within their capacity to ensure that where the corporation employs others in hazardous activities, the directors will in good faith establish corporate policies that are reasonably oriented towards having the corporation meet its legal requirements as to worker safety and public safety. Serving the “best interests of the corporation” would involve ensuring that the corporation does not run afoul of laws binding upon it. 33 - A personal duty of care of corporation directors toward corporation employees should be found in circumstances where: a) The director has or ought to have personal factual awareness of serious and avoidable or reducible danger to which the corporation’s employees are exposed in relation to corporation-related activities b) It is within the authority of the director to envision, establish and enforce corporate policies which could reasonably avoid or reduce such serious danger and c) It is within the reasonable capacity of the director to envision, establish and enforce the actions necessary to carry out such policies and to reasonably avoid or reduce such serious danger. Comments “This obligation falls to the director personally because all the characteristics giving rise to the duty of care by the director are personal, not vicarious. The obligation is realistic to impose on the directors because the danger must be serious, i.e. it foreseeably threatens life, limb or psychological health, not that transitory or trifling perils await.” Note: This is closer to a tort-type duty of care. CCQ 321. A director is considered to be the mandatary of the legal person. He shall, in the performance of his duties, conform to the obligations imposed on him by law, the constituting act or the by-laws and he shall act within the limits of the powers conferred on him. Recall that: CCQ 2138. A mandatary is bound to fulfill the mandate he has accepted, and he shall act with prudence and diligence in performing it. He shall also act honestly and faithfully in the best interests of the mandator, and avoid placing himself in a position that puts his own interest in conflict with that of his mandator. CCQ 322. A director shall act with prudence and diligence. He shall also act with honesty and loyalty in the interest of the legal person QCA 123.83. Directors, officers and other representatives of a company are mandataries of the company. QCA 123.84. A director is presumed to have acted with appropriate skill and with prudence and diligence if he relies on the opinion or report of an expert to take a decision. QBCA 119. Subject to this division, the directors are bound by the same obligations as are imposed by the Civil Code on any director of a legal person. Consequently, in the exercise of their functions, the directors are duty-bound toward the corporation to act with prudence and diligence, honesty and loyalty and in the interest of the corporation. In their capacity as mandataries of the corporation, the OFFICERS are bound, among other things, by the same obligations as are imposed on the directors under the second paragraph. Duty of Skill Re City Equitable Fire o A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. o A director is not bound to give continuous attention to the affairs of his company. His duties are of an intermittent nature to be performed at periodical board meetings and at meetings of any committee of the board upon which he happens to be placed. o In respect of all duties that having regard to the exigencies of business and the articles of association may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly. o Query: What level of skill did the common law require and what are the repercussions of this? 34 Tufo, Camion, Niziblian Summer 2010 Note: This case has been overruled by the legislature. Duty of Skill, Care, and Diligence o Because the common law was not strict, section 122 of the CBCA was enacted requiring directors and officers to exercise care, diligence, and skill that a reasonably prudent person would exercise in comparable circumstances o Compare the standard to that required in Quebec - A director shall act with prudence and diligence (CCQ 322; QBCA s. 119) Smith v. Van Gorkom (1985) Jurisdiction Delaware Facts Trans Union was struggling with its inability to use all its investment tax credits because its profits were insufficient. Its stock had been trading between $29 and $38 over the previous year. Management discussed a number of alternatives including a leveraged buy-out by management itself. A rough calculation by Romans, the CFO, indicated that at a share price of $50 the debt could easily be paid off by the corporation’s tax flow, but that at $60 it would be difficult to retire the debt. Van Gorkom was the CEO and chairman of the board. He was nearing the mandatory retirement age of 65 and indicated he would be willing to sell his 75,000 shares at $55 a share. He decided to approach the head of another corporation, Pritzker, with a proposal that Pritzker purchase all the outstanding shares of Trans Union for $55 per share. He presented Pritzker with calculations indicating that most of the debt required to purchase all the outstanding shares could be retired over five years from Trans Union’s cash flow. Pritzker showed interest and proposed that if Van Gorkom made an offer of $55 per share, he would receive 1,000,000 shares of Trans Union stock at $38 per share. He also insisted that the board of Trans Union accept the merger agreement within three days. For 90 days after the merger agreement was accepted, Trans Union could receive but not solicit competing bids. The board met and heard presentations from Van Gorkom, the corporation’s vice-president, outside counsel, and the CFO over a period of two hours before agreeing to the merger. The CFO made it clear that the calculations leading to the $55 price were not the result of trying to determine the value of the shares, but the price at which the cash flow of Trans Union would allow the debt incurred in a buyout to be repaid over five years. He did, however, express the opinion that the $55 price was in the range of a fair price, but at the beginning of that range. The board members did not have an opportunity to review the merger agreement in detail before they agreed to it. A few weeks later, after a rebellion against the merger by senior management of Trans Union, Pritzker agreed to amendments to the merger agreement, including one permitting Trans Union to solicit bids. Trans Union began to solicit bids, but none were finalized and the shareholders of Trans Union voted to accept Pritzker’s bid. Issues Application of the Business Judgment Rule / Duty of Care Holding The rule does not apply here / Duty of care not met. Ratio The Business Judgment Rule - The rule is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. The party attacking a board decision must rebut that presumption. - The fulfillment of the fiduciary function requires more than the mere absence of bad faith or fraud. Here there are no presumptions of fraud, bad faith or self-dealing. It is presumed that the directors reached their decision in good faith and considerations of motive are thus irrelevant. - The director’s duty to exercise an informed business judgment is in the nature of a duty of care, as distinguished from a duty of loyalty. - The concept of gross negligence is the proper standard for determining whether a business judgment reached by a board of directors was an informed one. 35 - As far as the defense of the shareholder approval is concerned, only an agreement of merger satisfying the statutory requirement of duty of care to act in an informed and deliberate manner may be submitted to the shareholders. - The directors: a) Did not adequately inform themselves as to Van Gorkom’s role in forcing the sale of the company and in establishing the per share purchase price b) Were uninformed as to the intrinsic value of the Company c) Given these circumstances, were grossly negligent in approving the sale of the company upon two hours’ consideration, without prior notice, and without the exigency of a crisis or emergency. - Few members of senior management were present and those present had only just learned of the proposal. They had no documents before them but relied on Van Gorkom’s 20- minute oral presentation. - The Board accepted without scrutiny Van Gorkom’s presentation as to the fairness of the share price – a matter that the board had never previously considered. - There was no market test as to the share price because Trans Union could not solicit bids and the public announcement of the agreement did not indicate that it could receive unsolicited bids. The text of the subsequent amendment did not permit recission of the agreement with Pritzker unless another merger was consummated. Other provisions of the amendment had the effect of reducing the period for the market test. - Collective experience and sophistication does not turn what seems to be a hasty and ill- informed decision into an informed and reasonable one. - The fact that Delaware law did not require a fairness option or an outside valuation did not justify the directors’ failure to ensure that they had adequate information about the value of the company before accepting the offer. Dissent: Given the experience and expertise of the directors, they were not helpless victims unable to assess the transaction. They were qualified to make an on-the-spot informed judgment because they knew the company like the back of their hands. Note: Effects of Van Gorkom o Made it harder to interest people in serving as outside directors o Pushed up rates for director and officer insurance. o Encouraged excessive risk averse behaviour by directors which could inhibit firm growth o Del. 102(b)(7) – Compare CBCA s. 122(3) (eliminates personal liability of directors for failing to meet DOC in good faith – the corporation would indemnify directors when they failed to meet their duty of care. This is only the case in the US. In Canada, you cannot limit the breach of DOC by a director. A corporation can indemnify you or give you insurance but there are a lot of restrictions. Even in the US, courts now consider the DOC to be a subset of the duty of loyalty which makes it virtually impossible for one to be protected under 102 (b)(7). In Canada, the distinction between DOL and DOC remains. Duty of Care (BCE v. 1976 Debentureholders (SCC)) o The duty of care is not owed solely to the corporation, and thus may be the basis for liability to other stakeholders in accordance with principles governing the law of tort and extra-contractual liability o Section 122(1)(b) of the CBCA does not provide an independent foundation for claims. However, courts may take this statutory provision into account as to the standard of behaviour that should reasonably be expected Note: Confirms decision in Peoples. DOC reformulated as standard of care. The standard is owed to more than just the corporation. Cannot sue on the basis of this standard. Could try to slot it in under the duty of 36 Tufo, Camion, Niziblian Summer 2010 loyalty, i.e. if this standard was breached, you could say that it indicates a breach of the duty of loyalty as well. (Irony: broadening the scope of DOC but narrowing the possibility of suing under it). This is best used in the context of oppression claims. In Quebec, one can still bring a claim under the DOC because of the 1457 reference. Can also sue under DOC in Ontario for provincially incorporated companies. Choudhury: It doesn’t matter so much because it’s so hard to bring a DOC case anyway. (Can go via Nielsen if it’s a tort). o The content of this duty is highly dependent on the facts o The duty of care sets an objective standard by referring to the care, diligence and skill of a reasonably prudent person o The duty of care is not an obligation owed to the corporation, at least not exclusively, but represents a standard of behavior to be observed in relation to creditors and other stakeholders as well Criticisms of the SCC’s Approach to the Duty of Care o The SCC’s approach to DOC conflates the traditional conception of DOC as a standard of competence that is owed to the corporation by directors and officers in carrying out their duties on behalf of the corporation with the standard of care required by tort law that is owed to anyone who under tort principles is owed a duty of care o The content of the resulting standard will likely be the subject of substantial litigation o Already, the OBCA has been amended in s. 24 to hold that the duty of care is owed only to the corporation. The Business Judgment Rule Meant to encourage efficiency o Deference by courts to decisions made by the directors where they have been duly diligent and where the decision was informed in all the circumstances o BJR is permitted because courts do not have the business or commercial expertise to assess all decisions made by directors and officers, and because their review of the decision is made with the benefit of hindsight o This is very unique to the business context. Courts rarely give deference to individuals. Note: Clashes with Peoples, which is yet another reason why Choudhury believes Peoples was wrongly decided. Reasons for the Business Judgment Rule o A failure to give deference to business judgments made in good faith and on a duly diligent basis could encourage shareholder or creditor actions where they are unhappy with officers’ decisions in hindsight and could create inappropriate incentive effects for such stakeholders o Directors and officers may be unwilling to act or to make decisions out of fear that those decisions will be overturned by the courts, in turn creating an ineffective or paralyzed governance structure Review of Decisions by Courts Under BJR o Courts undertake a process inquiry and assess the substantive decision based on a standard of reasonableness in the circumstances. o If directors have acted within a range of reasonableness, the court will not substitute its own opinion for that of the board, even though subsequent events may have raised doubts about the validity of the decision BJR in a Nutshell o If a business decision has been made honestly, with due care, and on an informed basis, then the substance of that decision will be protected by BJR o Directors who wish to rely on BJR will need to ensure that the above pre-conditions have been established. o Directors will need to demonstrate only that the process they followed was appropriate; they are not 37 required to justify the substance of their business decisions o Finally, perfection is not required VII. FIDUCIARY DUTY / DUTY OF LOYALTY Duty of Loyalty Common Law CBCA 122. (1) Every director and officer of a corporation in exercising their powers and discharging their duties shall (a) act honestly and in good faith with a view to the best interests of the corporation. Civil Law QCA 119. ... in the exercise of their functions, the directors are duty bound toward the corporation to act with ... honesty and loyalty and in the interest of the corporation. CCQ 322. A director shall act ... with honesty and loyalty in the interest of the legal person Conflicts between corporate duty and personal interests o At its core, the duty of loyalty speaks to the obligation of directors and officers to put the interests of the corporation they serve ahead of their own interests o The potential for this conflict arises in instances of: - Self dealing - Directors’ and officers’ remuneration - Corporate opportunities - Hostile takeover bids Self-Dealing o Involves contracts or transactions concluded between the directors and officers of a corporation, either directly or through their interest in another entity, and the corporation itself o Dangers entailed by self-dealing: possible diversion of corporate wealth o Example: - Sale of an asset to the corporation by a director at a price that exceeds the asset’s fair market value - The price differential at the corporation’s expense constitutes an “unbargained for” diversion of wealth from shareholders to the interested party and an agency cost Aberdeen Ry. Co. v. Blaikie Brothers (1854) Jurisdiction UK (HL) Facts The Railway contracted to purchase chairs from Blaikie Brothers. Thomais Blaikie, chairman of the Railway, was also a partner in Blaikie Brothers. Some of the chairs were delivered but the railway refused the delivery (unknown reasons). BB was sued for specific performance. The railway defended itself on grounds that it could avoid the contract because its chairman had a pecuniary interest in it as a partner in the vendor firm. At trial, the defense was rejected. Issues Is a director precluded from dealing on behalf of the company with himself or with a firm in which he is a partner? Holding Yes. Reasoning o No one with a fiduciary duty is allowed to enter into engagements in which he has a personal interest conflicting with those whom he is bound to protect. o A corporate body can only functions through agents, and these agents must act in the best interests of the corporation. o The inability to contract depends not on the subject matter of the agreement, but on 38 Tufo, Camion, Niziblian Summer 2010 the fiduciary character of the contracting party who is acting as a manager of a business for the benefit of others. o Here, Blaikie was not only a director but the chairman of directors; he was to make make the best bargains he could for the benefit of the company o His personal interest would lead him in an entirely opposite direction, inducing him to fix the price as high as possible. This is the very evil against which the rule is directed. Question: Should there be a prophylactic rule for self-dealing? o A rule voiding all contracts in which directors and officers have an interest, such as that set forth in Aberdeen Ry., will impose costs on corporations o But in the case of interested directors’ contracts, the fear is that management will cause the firm to enter into bargains that transfer wealth to the directors North-West Transportation Co. v. Beatty  Jurisdiction Ontario / Privy Council Facts Beatty, one of the directors of North-West Transportation, had a boat he wanted to sell to the company [what a smart alec!]. In order to effect the sale, he became the owner of more than half the shares of the company, a few of which he transferred to the other defendants, Rose and Laird. At the first annual meeting thereafter, the three of them were elected directors and constituted a majority of the board, which was composed of five. The board passed a by- law authorizing the purchase of the boat by the company. At the meeting of the shareholders where the by-law was confirmed, Beatty voted for the confirmation. Without his vote the resolution could not have been passed as he voted on nearly half the stock of the company. The plaintiff, one of the shareholders of the company who voted against the resolution, took proceeding on behalf of himself and other dissentient shareholders to have the sale of the boat to set aside. The chancellorordered it to be set aside. The Court of Appeal reversed, holding that though the by-law was illegal, the action of the shareholders was lawful, and effected a valid contract of sale. The plaintiff appealed to the Supreme Court of Canada which annulled the sale. Issues Should the sale of the boat be aside for reason of self-dealing? Holding No. Reasoning o Unless some provision to the contrary is found in the charter by which the company is incorporated, the resolution of a majority of the SHs duly convened, upon any question which the company is legally competent to deal, is binding upon the minority, and the company. Every SH has a right to vote on such questions, including when they have a personal interest opposed or different to that of the company. o A director of a company is precluded from self-dealing, but any such dealing or engagement may be affirmed or adopted by the company, provided such affirmance or adoption is not brought about by unfair or improper means, and is not illegal or fraudulent or oppressive towards those shareholders who oppose it o The transaction was fair because the purchase of the steamer was: - Essential to the efficient conduct of the company’s business and well adapted for that purpose; - It was not within the power of the company to acquire any other steamer equally well adapted for its business; and - The price of the steamer was not excessive or unreasonable. o There would normally be no reason to set the sale aside, except for the fact that the resolution was brought about by unfair and improper means: the same day the purchase was agreed upon, Beatty was transferred 101 shares, making him a controlling SH, and during the same meeting, he became a director. The by-law that ratified the purchase was passed and confirmed in the meeting of the directors due to the votes of Beatty o The Supreme Court of Canada ruled that the interested director’s contract could be 39 ratified only by a disinterested majority of the SHs o The House of Lord says that although the majority of the directors was not disinterested, it was the competency of the SHs to adopt or reject the purchase. The SHs did adopt in due form and terms at the SHs meeting o The constitution of the company allowed Beatty to have SH voting rights, which he could use to secure the election of directors who agreed with his views. o The Supreme Court of Canada held that the use of Beatty’s SH voting powers was oppressive, but the House of Lords disagrees: Beatty had acted within his voting rights, though he could have done so in a manner less likely to give rise to an objection. Comments I say Beatty had friends in the House of Lords! Gray v. New Augarita Porcupine Mines (example of individual dominating board of directors) o Self dealing by a director can be ratified by the board of directors if: - The self-interested director does not vote on a resolution dealing with the contract and - The nature of the director’s interest is disclosed to the board, the onus being on the director to establish that he has satisfied these conditions. Whilst there is no precise formula that will determine the extent of detail that is called for when a director declares his interest, if it is material to their judgment, he must enlighten his fellow directors fully as to the real nature of his interest and how far it goes. When his interest consists of the fact that he stands to gain a great deal by a transaction wherein only he has the means of knowing how much, it is imperative that his declaration make his colleagues fully informed of the real state of affairs. Legislative Response Common Law CBCA 120. (1) A director or an officer of a corporation shall disclose to the corporation, in writing or by requesting to have it entered in the minutes of meetings of directors or of meetings of committees of directors, the nature and extent of any interest that he or she has in a material contract or material transaction, whether made or proposed, with the corporation, if the director or officer (a) is a party to the contract or transaction; (b) is a director or an officer, or an individual acting in a similar capacity, of a party to the contract or transaction; or (c) has a material interest in a party to the contract or transaction. Civil Law QBCA 122. A director or officer of a corporation must disclose the nature and value of any interest he or she has in a contract or transaction to which the corporation is a party. For the purposes of this subdivision, “interest” means any financial stake in a contract or transaction that may reasonably be considered likely to influence decision-making. Furthermore, a proposed contract or a proposed transaction, including related negotiations, is considered a contract or transaction. QBCA 123. A director or an officer must disclose any contract or transaction to which the corporation and any of the following are a party: (1) an associate of the director or officer; (2) a group of which the director or officer is a director or officer; (3) a group in which the director or officer or an associate of the director or officer has an interest. The director or officer satisfies the requirement if he or she discloses, in a case specified in subparagraph 2, the directorship or office held within the group or, in a case specified in subparagraph 3, the nature and value of the interest he or she or his or her associate has in the group. 40 Tufo, Camion, Niziblian Summer 2010 Safe-Harbor Common Law CBCA 120. (1) A director or an officer of a corporation shall disclose to the corporation, in writing or by requesting to have it entered in the minutes of meetings of directors or of meetings of committees of directors, the nature and extent of any interest that he or she has in a material contract or material transaction, whether made or proposed, with the corporation, if the director or officer (a) is a party to the contract or transaction; (b) is a director or an officer, or an individual acting in a similar capacity, of a party to the contract or transaction; or (c) has a material interest in a party to the contract or transaction. (7.1) Even if the conditions of subsection (7) are not met, a director or officer, acting honestly and in good faith, is not accountable to the corporation or to its shareholders for any profit realized from a contract or transaction for which disclosure is required under subsection (1), and the contract or transaction is not invalid by reason only of the interest of the director or officer in the contract or transaction, if (a) the contract or transaction is approved or confirmed by special resolution at a meeting of the shareholders; (b) disclosure of the interest was made to the shareholders in a manner sufficient to indicate its nature before the contract or transaction was approved or confirmed; and (c) the contract or transaction was reasonable and fair to the corporation when it was approved or confirmed. Civil Law QBCA 132. A contract or transaction for which a disclosure required by section 122 or 123 was made may not be declared null if the contract or transaction was approved the board of directors and the contract or transaction was in the interest of the corporation when it was approved. Nor may the director or officer concerned, in such a case, be required to account for any profit or gain realized or to remit the profit or gain to the corporation. Note: The difference between the QBCA and the CBCA is that under the QBCA, one can still vote. Safe harbors can also be provided by SH ratification (CBCA s. 120(7.1)), but in the QBCA it must come from disinterested shareholders (QBCA s. 133.: the contract or transaction was approved by ordinary resolution by the shareholders entitled to vote who do not have an interest in the contract or transaction). SH ratification of directors’ breaches is not necessarily decisive (CBCA, s. 242 / QBCA, s. 440) Note: It seems upon reading that the director would also be able to vote but is probably not the case once litigated. UPM-Kymmene Corp. v. UPM-Kymmene Miramichi Inc.  Ontario In the context of a director-corporation transaction, there are duties of disclosure. The director must make his colleagues “fully informed of the real state of things”; it’s not just a mere “I remind you that I have an interest here.” Saying that the directors could have found out some info by themselves is not an excuse CBCA s. 120 does not set out any procedural standards to establish the fairness of a contract; but major interested contracts will often be approved by a committee of independent directors, and certified as independent by securities firms or investments bankers. The scope of the review by firms or banks is generally specified by the independent committee but since it bears the costs of an inadequate review, the scope of the review might be left to the determination of the firm. How Interested Does a Director Have to Be? o Does not have to be a pecuniary interest - i.e. Transvaal Lands Co. -where a director of a corporation holds shares in another corporate party to a contract as trustee, rather than beneficially, that interest is sufficient to attract the conflict of interest prohibition 41 o Can be an interest based on a close personal relationship with the principal of the counterparty o Can include a directorship in another corporate party to the transaction Perlman v. Feldman (1955) Jurisdiction Ontario / Privy Council Facts - Newport (corporation) - Feldmann (family and friends owned 37 percent, effectively controlled corp.) - Minority stockholders - Wilport (bought Feldmann Group shares) Newport Steel was a steel manufacturer. Plaintiffs and Defendants were shareholders. Due to the Korean War, steel was at a premium and it turned Newport Steel into a more profitable venture. The Truman administration imposed price controls, limiting the maximum price firms could charge for steel. A consortium of end-users called Wilport Co, bought the Defendants’ shares in an effort to secure more steel output. The over-the-counter price for the shares was $12 and the book value was $17.03, but Wilport paid $20 per share. The Plaintiffs, a minority, sued to receive the same premium (attributable to the sale of corporate power) for their shares, and the trial court denied their claims. The trial court ruled that the premium was an inherent benefit of having a controlling ownership, and alternatively, that the burden was on the Plaintiffs to prove the lesser value of the stock. Issues Are the Plaintiffs entitled to a share of the premium paid by Wilport attributed to the sale of corporate power? Holding Yes. Reasoning A majority shareholder - particularly when also president and chairman of the board - who sells his shares to a third party who then obtains a controlling interest, owes the minority shareholder their share of the premium paid by the third party for the controlling interest. o Feldmann was the president and dominant shareholder, and in both positions he owed a fiduciary duty to minority shareholders not to let a personal interest override the interests of all the shareholders. o The burden is on the shareholder to prove that this is not the case. The court is not holding that the dominant shareholder is not able to sell his shares. But Feldmann did not meet his duty in the sale of his shares. The court noted that there only had to be a possibility that the Defendants misappropriated a corporate opportunity and not an absolute certainty. The facts demonstrate that there was a shortage of steel and that the Defendants took advantage of this to obtain a market premium for their shares. o We do not mean to suggest that a majority stockholder cannot dispose of his controlling block of stock to outsiders without having to account to his corporation for profits or even never do this with impunity when the buyer is an interested customer, actual or potential, for the corporation's product. But when the sale necessarily results in a sacrifice of this element of corporate good will and consequent unusual profit to the fiduciary who has caused the sacrifice, he should account for his gains. So in a time of market shortage, where a call on a corporation's product commands an unusually large premium, in one form or another, we think it sound law that a fiduciary may not appropriate to himself the value of this premium. Such personal gain at the expense of his coventurers seems particularly reprehensible when made by the trusted president and director of his company. Dissent. The dissent does not argue that Feldmann owed the Plaintiffs a fiduciary duty, but that Feldmann did not violate any duty. As a majority shareholder, he was entitled to sell his shares for the best price he could receive. There was no evidence that Wilport was going to abuse their control or not act in the best interests of the other shareholders. Peoples and the Duty of Loyalty 42 Tufo, Camion, Niziblian Summer 2010 It is not required that directors and officers in all cases avoid personal gain as a direct or indirect result of their honest and good faith supervision or management of the corporation. In many cases the interests of directors and officers will innocently and genuinely coincide with those of the corporation. If directors and officers are also shareholders, as is often the case, their lot will automatically improve as the corporation’s financial condition improves. Another example is the compensation that directors and officers usually draw from the corporations they serve. This benefit, though paid by the corporation, does not, if reasonable, ordinarily place them in breach of their fiduciary duty. Therefore, all the circumstances may be scrutinized to determine whether the directors and officers have acted honestly and in good faith with a view to the best interests of the corporation. VIII. CORPORATE OPPORTUNITIES Instances in which directors and managers of corporations have appropriated business or investment opportunities that might have gone to the corporations they serve are known as corporate opportunity cases. A corporate opportunity is more significant than self-dealing as it actually takes something away from the corporation. Regal (Hastings) Ltd. V. Gulliver (1942) Jurisdiction UK (HL) Facts Regal was a corporation that owned and managed a cinema called… the Regal. One day, Regal’s board decided to try to acquire the lease of two other cinemas from a company called Elite through a subsidiary, Amalgamated, whose shares would be 100% owned by Regal. Regal’s solicitor carried out the negotiations and Elite accepted. Because Regal could afford to put up only L2000 in Amalgamated and because one of the directors objected to Regal guaranteeing its rent, it was resolved that the individual directors would be invited to subscribe for 500 shares of Amalgamated each. At the same time, Regal was considering selling all of its assets including the leases acquired from Elite. An offer was received, with L77500 allotted as the price of Regal’s cinema, and L15000 as the price of the two leasehold cinemas. The board accepted the offer. The proposed sale and purchase of the Regal cinema and the two leaseholds fell through, but another proposition took its place: a proposal for the purchase from the individual shareholders of their shares in Regal and Amalgamated. The proposal was accepted and 3,000 shares in Amalgamated held otherwise than by Regal were sold for a sum of L3 per share (at a profit of L2 per share over the issue price). After the sale of the shares in Regal, the company came under the management of a new board of directors which initiated litigation seeking to recover from Regal’s five former directors and its solicitor the sum of L8142 either as damages or as money had and received to the plaintiff’s use. Issues Are the directors of Regal liable for the profits they made by reason and in the course of their fiduciary duty to Regal? Holding Yes. Ratio o The rule of equity which insists that those who by use of a fiduciary position make a profit are liable to account for that profit in no way depends on fraud or the absence of bona fides, or upon whether the profit would or should have otherwise gone to the plaintiff, or whether the profiteer was under a duty to obtain the source of the profit for the plaintiff, or whether he took a risk or acted as he did for the benefit of the plaintiff, or whether the plaintiff has in fact been damaged or benefited by this action. o The liability arises from the mere fact of a profit having, in the stated circumstances, been made. The profiteer, however honest and well-intentioned, cannot escape the risk of being called upon to account. o In the present case, the effect of the change of scheme which only the Regal directors could bring about had a profound effect upon the company and its shareholders: Regal would no longer control Amalgamated or own the whole of its share capital; Regal shareholders would only receive a largely reduced proportion of the sale price of the two leased cinemas. The Regal directors and solicitor would receive the money of which the 43 shareholders were thus deprived. o The directors obtained the shares by reason only of the fact that they were directors of Regal and in the course of the execution of that office. o The argument that Regal itself lacked the funds to buy the shares and that the directors, in buying the shares, were presumably acting as members of the public cannot be accepted. They should have protected themselves by a resolution of the Regal shareholders. o The solicitor is let of the hook as the directors had instructed him to purchase shares. Comments The reason why courts pay little heed to the impossibility argument is probably because the defendants are usually in control of the corporate possibilities. If directors could thus justify their conduct, there would be a temptation to refrain from exerting their best efforts on behalf of the corporation so that the opportunity to profit would open to them personally. Note: Think about this from the law and economics perspective. Minority shareholders will probably not bring suit because they were not damaged, however, the duty of loyalty has nevertheless been breached. Peso Silver Mines Ltd. V. Cropper (1966) Jurisdiction SCC Facts This was an action by Peso Silver Mines against Cropper, one of its founding directors, for a declaration that shares owned by Cropper in Cross Bow Mines and Mayo Silver Mines were held by him as trustee for Peso or, in the alternative, that Cropper was liable to account to Peso for the proceeds of those shares. The shares had been purchased by Cropper, together with a few other individuals who established a new corporation, after Peso’s board of directors had turned down the opportunity. It was found at trial that that decision had been honest and considered. Issues Is Cropper accountable to Peso for the shares? Holding No. Ratio o There is no suggestion in the evidence that the offer to the appellant was accompanied by any confidential information unavailable to any prospective purchaser or that Cropper as director had access to any such information by reason of his office o When he had been approached to purchase the shares it was not in his capacity as Peso’s director but as an individual member of the public. Comments There is no prohibition at common law or by statute against a person being the director of a competing corporation. Cropper was involved in a number of different mining ventures simultaneously, a common pattern in the junior mining industry. The decision in Peso is thus consistent with the accepted norm in that industry. Also note that the purchase of a mining stake is speculative so that Cropper could not have known that his purchase would actually lead to profits (he took a risk which Peso didn’t want to take). Abbey Glen Property Corp. v. Stumborg (1978) Jurisdiction Delaware Facts The Stumborg brothers were officers and directors of Abbey Glen’s predecessor corporation, Terra Developments. Terra was a land developer in the Edmonton area. Certain syndicates in which other Stumborg-controlled corporations were substantial participants owned two large parcels of land in Edmonton. The Stumborgs approached Traders Financial Corp. of Toronto on behalf of Terra in order to try to arrange a joint venture between Terra and Traders for the development of the two parcels. Traders refused to deal with Terra because Terra was publicly held. The Stumborgs and Trade then formed a new corporation, Green Glen, to develop the parcels, and the venture was a great success. Issues Are the Stumborg’s accountable to Abbey Glenn for their profits from Green Glen? Holding Yes. Robinson v. Brier (1963) Jurisdiction ? Facts Brier, together with the Robinsons, owned all shares of L Corp. Brier was also the director 44 Tufo, Camion, Niziblian Summer 2010 and manager of L’s wholly owned subsidiary, M Corp., the business of which was the assembly of soft luggage. Brier had various other business interests, as was known to the Robinsons. Brier determined that the price paid by M Corp. for the wooden frames for luggage were excessive. He convinced the frame suppliers to reduce the prices but eventually concluded that S Corp., of which he was the sole owner, could produce the frames still cheaper. S Corp. began to manufacture and sell frames to M Corp. at a price lower than M Corp. had been able to obtain anywhere else. The Robinsons sued on behalf of M Corp. to recover Brier’s profits from S Corp.’s frame sales. Issues Is Brier accountable to M Corp. for the profits of S Corp’s frame sales? Holding No. Ratio At the time when S Corp. started manufacturing frames, all of M Corp’s available space was being used for luggage assembly and M Corp was behind in filling orders from various large customers. Therefore, there was no usurpation of corporate opportunity. Note: Can you really take away an opportunity that the corporation was unable to pursue? If the director doesn’t pursue the opportunity, someone else will! Canadian Aero Service Ltd. V. O’Malley (1974) Jurisdiction SCC Facts Canaero was a subsidiary of a US corporation and was in the business of topographical mapping and geophysical exploration. O’Malley was its president and CEO until he resigned in 1966. Zarzycki was executive VP and director until he resigned in 1965. Wells was a director who ceased to be director in 1965. Wells suggested that the three form a company of their own due to their discontent on the limits placed on Canaero by the US parent, and their concerns about job loss if Canero failed to get contracts. In 1965, they formed Terra Surveys Limited, a company through which they could pursue the same contracts as Canaero. The contract at issue was the topographical mapping and aerial photographing of Guyana to be financed by the Government of Canada. Canaero had been working on promoting the project since 1961, and both O’Malley and Zarzycki had been involved. Canada’s external aid policy was to give preference to Canadian incorporated companies that were managed and operated from Canada and employed Canadians. Canaero and Terra both bid for the project and Terra’s bid was successful. Issues 1) What was the relationship of O’Malley and Zarzycki to Canaero? 2) Do they owe any duties of Canaero by virtue of this relationship? 3) Was this duty breached? 4) Is there liability for this breach of duty? Holding 1) They were president and vice president of Canaero for two years prior to their resignation, i.e. top management as opposed to mere employees. 2) They owed a fiduciary duty to Canaero. 3) Yes. 4) Yes. Ratio - It does not matter whether the two were directors of Canaero or not. By virtue of being senior managers, theirs was a larger and more exacting duty than that of mere employees, similar to that owed by directors. - They stood in a fiduciary relationship to Canaero, which calls for loyalty, good faith, and the avoidance of a conflict of duty and self-interest. They were thus precluded from obtaining for themselves any property or business advantage either belonging to Canaero or for which Canaero had been negotiating, especially as they themselves had been involved in these negotiations. - The fact that the two slightly varied the project in their own bid is irrelevant. It was still the same project. - Whether or not Terra was created to intercept this particular project is also irrelevant. Honesty of purpose is no defense. - There is a huge gulf between this case and Peso where the company’s interest in the claims acquired by its director had already ceased. - There was... no certain knowledge at the time O’Malley and Zarzycki resigned that the 45 Guyana project was beyond Canaero’s grasp Comment Things to be taken into account in ascertaining whether there has been a usurpation of a corporate opportunity: position held, the nature of the opportunity, its ripeness, its specificity, the director or manager’s relationship to it, the amount of knowledge possessed, the circumstances in which it was obtained, whether it was private, the factor of time in the continuation of the fiduciary duty where the alleged breach occurs after termination of the relationship with the company, and the circumstanced under which the relationship was terminated. Note: Should the fiduciary duty extend beyond the director’s employment with the corporation? Maybe it depends on the circumstances, i.e. did the director quit the corporation just so that she could pursue the opportunity? Also, note that this is not the same as simply leaving to go and work for someone else. If the corporate opportunity belongs to the corporation, you cannot take it with you. Would these guys have even come across this opportunity had they not worked for Canaero? Gravino c. Enerchem Transport inc. (2008) Jurisdiction Quebec (CA) Facts Having learned that a certain oil company had excess shipping capacity, three officers of Enerchem Transport Inc. (ETI), a provider of marine transportation services, commenced negotiations to have ETI sub-charter certain tankers from that oil company. Two of these officers were also directors and shareholders of ETI at the time. In February 1996, the two officers in question exercised their put-call options under ETI's unanimous shareholder agreement, thereby liquidating their interest in ETI, and subsequently terminated their employment with ETI. After they left ETI, they formed a new business - Petro-Nav - and began negotiations to have Petro-Nav sub-charter the same tankers. In the spring of 1997, Petro-Nav succeeded in sub-chartering the tankers. After the tankers were chartered out to Petro-Nav, ETI instituted legal proceedings against its two ex-officers, contending that they had breached their duties toward ETI. Issues Holding Ratio The reasons for judgment deal with the following three issues: a) the application of the non- competition clause b) the duty to act with honesty and loyalty and c) the concept of a maturing business opportunity. Non-Competition Clause The Court of Appeal confirmed the trial judge's findings on the question of the application of the non-competition clause between ETI and its ex-officers, and reaffirmed that the lifting of such a clause operates to allow free competition as long as the general rules of the Civil Code of Québec are respected. Those that are supplementary in nature can be overridden by contract, but rules that are of mandatory application, such as the duty of loyalty of a corporate officer or director, cannot. Among other things, the Court relied on the decision in Marque d'Or inc. v. Clayman, which was handed down under the rules of Quebec's old Civil Code. Duty to Act With Honesty and Loyalty The Court of Appeal confirmed in part the trial judge's findings on the question of the duty to act with honesty and loyalty. The Court explained that in order to determine the scope of the duty to act with honesty and loyalty, it was necessary to consider the applicable provisions of the Civil Code of Québec along with the principles laid down by the Supreme Court of Canada in Canadian Aero Service Ltd. v. O'Malley and the cases that had followed in its wake. The Court concluded that the duty of loyalty owed to ETI by its ex-officers in this case was all the greater given the high level of responsibility of the positions they had held with the company. Maturing Business Opportunity - The Court began its analysis of this question by noting that the concept of a "maturing business opportunity" as such was not found in the Civil Code of Québec. Rather, it was 46 Tufo, Camion, Niziblian Summer 2010 incorporated in the prohibition, found in article 323 C.C.Q., that bars a director from using for his own profit or that of a third party any information he obtains by reason of his duties, unless he is authorized to do so. - However, the Court went on to point out that this prohibition was not a substitute for a negotiated non-competition clause, and that in the absence of any conflict of interest, borrowing what was merely a business idea would be without consequence. - The Court identified four main factors that had to be weighed in order to determine whether misappropriation of a maturing business opportunity had taken place: i) the degree to which the interests of the director and the interests of the company were in conflict, ii) the degree to which the business opportunity had, at the time in question, acquired its own specific and identifiable character, iii) the proximity in time between the emergence of the business opportunity and its exploitation and iv) the proximity in character between the business opportunity pursued by the company and the contract or business concluded by the director for his own profit or the profit of a third party. - In the Court's view, apart from a situation where property had been misappropriated or clientele diverted, a business opportunity had to have acquired a level of specificity or identifiability sufficient to be almost autonomous" in order to be a maturing business opportunity subject to the prohibition of article 323 C.C.Q. - Among the criteria cited by the Court in support of its finding that the situation in this case did not amount to Petro-Nav or its principals usurping what was a maturing business opportunity for ETI, the following are worthy of note: the fact that the existence of the opportunity in question was generally known in business circles (as opposed to being confidential); the fact that the project was exploratory and hypothetical in nature (as opposed to being in an advanced state of completion; the fact that the defendants had had knowledge of the business opportunity even before a new shareholder acquired its interest in ETI (as opposed to learning about it specifically by reason of their duties); the absence of a continuing conflict of interest (the directors concerned having resigned from the board); and the fact that the opportunity that was ultimately exploited differed in its execution from the one that ETI had been pursuing. - In addition, the Court emphasized that in a market as limited as the one in which Petro- Nav and ETI were operating, a vague commercial purpose (in this case, that of acquiring the ability to operate ships) did not amount to a maturing business opportunity. Even though the opportunity exploited by Petro-Nav was consistent with the general goals ETI had been pursuing, the negotiations that had taken place between ETI and the third parties involved were too preliminary to serve as a basis for finding that a real business opportunity had existed. - In concluding its analysis, the Court noted that the criterion of elapsed time could not be dissociated from the analysis of a situation where a breach of the duty to act with honesty and loyalty was alleged. Comments - The Quebec Court of Appeal has confirmed that a contractual provision, even an explicit one, cannot override the duty of loyalty owed by a director or officer. The duty of loyalty survives the resignation of the director or officer, and the resulting prohibition against appropriating a business opportunity for his or her own benefit also survives the departure of the director or officer from the company, although the period of time for which the prohibition continues to apply will vary, depending on the circumstances of each case. - The tests developed by the Court of Appeal for determining the circumstances in which competition engaged in by a director or officer will result in the duty of loyalty being compromised (the degree of conflict of interest that existed, the degree of specificity of the project, the proximity in time and the degree of resemblance between the business opportunity being pursued and the one ultimately concluded) would indicate that the Court is sensitive to the fact that, in a free-market economy, freedom of competition is the basic rule. - Consequently, ex-directors or officers may, in certain circumstances, fulfil the duty of 47 loyalty owed to their former company while still pursuing, for their own or others' benefit, business projects that were started by them while they held office with the company. CCQ 323. A director cannot use for his own profit or that of a third party any information he obtains by reason of his duties, unless authorized to do so. Peoples It is not required that directors in all cases avoid personal gain as a direct or indirect result of their honest and good faith supervision or management of the corporation. In many cases the interests of directors and officers will innocently and genuinely coincide with those of the corporation U.S. Test for Corporate Opportunity (no equivalent in Canada) 1) The corporation is financially able to take the opportunity 2) The opportunity is in the corporation’s line of business (Is the opportunity one in which the corporation has fundamental knowledge, practical experience and the ability to pursue, logically and naturally adaptable to its business having regard for its financial position, and consonant with its reasonable needs and aspirations for expansion?) 3) The corporation has an interest or expectancy in the opportunity 4) By embracing the opportunity the officer or director would create a conflict between his or her self- interest and that of the corporation The Director of Many Corporations (Johnston) Johnston v. Greene (1956) Jurisdiction Delaware Facts The plaintiff, a shareholder of Airfleets, sued Odlum, Airfleets’ president and “dominant director” alleging that Odlum had diverted to his personal benefit a corporate opportunity belonging to Airfleets. At the relevant time, Airfleets was flushed with cash and looking for investment opportunities. Odlum was the director of Airfleets, of Atlas (Airfleets’ largest single shareholder), and various other corporations. Huston owned patents for the manufacture of self-locking nuts used in the manufacture of airplanes, as well as all the outstanding shares of Nutt-Shell, the exclusive licensee of the patents. He approached Odlum to offer him both these assets as he knew Odlum to be a prominent financier. Odlum’s solicitor advised Odlum that for tax reasons, it would not be good for both assets to be held in common. Odlum caused the stock to be offered to Airfleets. The board decided to buy the stock but not the patents. Odlum refrained from voting. He subsequently bought the patents for a syndicate of 35 individual investors including himself. Issues Did the opportunity to purchase the patents belong to Airfleets? Holding No Reasoning o It is one thing to say that a corporation with funds to invest has a general interest in investing those funds; it is quite another to say that such a corporation has a specific interest attaching in equity to every business opportunity that may come to any of its directors in his individual capacity. o The offer came to Odlum not as director of Airfleets but in his individual capacity. o If it was Odlum’s fiduciary duty to offer this opportunity to his corporation, the question arises: which corporation? He was the director of many. o There is nothing inherently wrong in a man of large business and financial interests serving as a director of two or more investment companies, and both Airfleets and Atlas must reasonably have expected that Odlum would be free either to offer to any of his companies any business opportunity that came to him personally, or to retain it for himself—provided always that there was no tie between any of such companies and the new venture or any specific duty resting upon him with respect to it. o The mere fact of having funds to invest does not ordinarily put corporations “in competition” with each other, as that phrase is used in the law of corporate opportunity 48 Tufo, Camion, Niziblian Summer 2010 o The business of Nutt-Shell had no connection to any business of Airfleets. Its acquisition by Odlum’s syndicate was thus not essential to the conduct of Airfleets’ business. Airfleets had no interest or expectancy in the Nutt-Shell business. IX. SHAREHOLDER AND CORPORATE REMEDIES - DERIVATIVE ACTIONS Types of Remedies o Derivative Actions - Actions initiated by a complainant for a wrong done to a corporation. Called “derivative” because it derives from the rights of the corporation. The corporation collects any damages that are awarded. o Oppression Remedy - Initiated by a complainant where acts or omissions of a corporation or the exercise of directors' powers effect a result that is "oppressive or unfairly prejudicial or that unfairly disregards the interests of any security holder, creditor, director, or officer. o Dissent and Appraisal Rights - Available to dissenting shareholders when certain specified fundamental changes have been undertaken by the corporation; the appraisal remedy refers to a requirement that the corporation purchase the dissenting shareholders' shares for fair value. o Compliance Orders - Available to a complainant, as defined by statute, or to a creditor, when certain fundamental corporate documents or the provisions of the corporate statute itself are not being complied with by the corporation o Liquidation or Dissolution (winding-up orders): - Action can be taken by a shareholder seeking dissolution of the corporation in cases where an "oppression" remedy would be available, where a unanimous shareholder agreement permits the shareholders to demand dissolution, or where it is otherwise "just and equitable" to do so. Derivative Actions o When directors or officers act in breach of their duties, it is the corporation, as a matter of law, that has been wronged. But who speaks for the corporation in such cases? o Wayward managers, who have already shown no compunction in violating their fiduciary duties, are unlikely to repent at once and authorize the corporation to launch a legal action against themselves. o It is for situations such as these that the derivative action was principally designed o A lawsuit initiated by a shareholder on behalf of the corporation, in cases where a wrong has been done to the corporation, but where, for some reason, the usual corporate decision makers have declined to initiate proceedings on the corporation's behalf o Described as "derivative" because the complainant derives his or her right to bring the action from the corporation itself o The corporation is really the proper plaintiff as it is the corporation that has been directly harmed, not the complainant o Corrects the common law rule from Foss v. Harbottle - The directors caused the company to purchase land from the defendants themselves at inflated prices, and to finance this purchase by mortgaging the very lands purchased. - The court found that, even if the company itself had a right to sue the directors in respect of these transactions, the plaintiffs (as shareholders) were not entitled in their individual capacities to bring this action. Foss v. Harbottle Rule Where a corporation has been wronged, the corporation alone-may sue in respect of that wrong Where a wrong is done to a corporation, that wrong may be cleansed if it is, in effect, "waived" (or perhaps confirmed) by the shareholders in a general meeting 49 Note: Legislation was needed to overcome this rule. Statutory Derivative Actions o CBCA ss. 238-240 and 242 codify the rules governing shareholder derivative actions; they require leave of court o The court will only permit the action to be brought under s. 239(2) if: a. The complainant has given reasonable notice to the directors of his intention to apply to the court for leave (requires simply one or two letters to the corporation’s solicitor to complain about the transaction), b. If the directors do not bring or diligently prosecute the action c. The complainant is acting in good faith d. The action appears to be in the best interests of the corporation Preconditions for Bringing a Derivative Action Primex Investments Ltd. v. Northwest Sports Enterprises Ltd. (1995) Jurisdiction British Columbia Facts Northwest owned a hockey team and began pursuing a basketball franchise for a new arena they were building. Arena Corp, a wholly owned sub of Northwest was building the arena. Griffiths, the majority SH of Northwest had formed another partnership in order to get a basketball franchise. He had confirmed to the board that the basketball franchise would rent space in the new arena. He and his partners had agreed to take over the arena from Northwest once it was built. They succeeded in a takeover bid. The outcome was that individual share value in Northwest diminished and minority SH sought leave to commence a derivative action against Griffiths and other directors. Issues 1) Does the petitioner have grounds for leave? 2) Was he acting in Good Faith? 3) Is the derivative action in the interest of the company? Holding Yes. Yes. Yes. (Oh Baby!) Reasoning 1) Leave: Petitioner satisfies art 225(3), (a) and (d) of BCBCA 2) Steps necessary to bring forward derivative action. Court looks into a) and b) a) Good faith: 1) Not out of spite 2) Is the petitioner trying to force the corporation to purchase stocks at a higher price (self-interest)? 3) Does the petitioner have a valid claim against the defendant? 4) Exception to 3) SH interest and those of the corporation align b) Interest of the corporation (Canada specific) as per First Edmonton Place. Is there an arguable case against the defendant/interest of the corporation: does the proposed action have a reasonable prospect of success? “Legal cost (of the derivative action) may be a factor but is not an important consideration when the Court is considering whether it is prima facie in the interests of the coporation to allow a member to pursue a derivative action under s. 225”. ***the corporation is the one that pays for the cost of the derivative action. Comments Mr. Justice Tysoe appears to tie the requirement of "good faith" to the test of the "interest of the company." He stated that where there is an arguable case, the applicant cannot be said to be acting in bad faith because he wants the company to pursue what he genuinely considers to be a valid claim. He also indicated that an applicant advancing self-interest is not necessarily acting in bad faith. The analysis discounts shareholder approval on the ground that there can be a difference between the interests of the shareholders who accept the bid and the interests of the corporation (in that case represented by the interests of the opposing minority of shareholders) 50 Tufo, Camion, Niziblian Summer 2010 Who Can Bring an Action? o CBCA s. 238 includes: - A registered or beneficial owner of a security (not just shares) of the corporation or any of its affiliates (option holders, debenture holders, etc.) - A former owner (someone who previously owned shares in the corporation, i.e. at the time of the alleged offence) - A director or officer, present or former, of the corporation or of any of its affiliates - The Director of Corporations appointed under CBCA s. 260 - Any other person the court deems “proper” Demand CBCA s. 239(2)(a) [See also s. 446 QBCA] provides that leave to bring a derivative action shall not be granted unless the plaintiff has “given reasonable notice to the directors of the corporation … of his intention to apply to the court under subsection (1) if the directors of the corporation … do not bring, diligently prosecute or defend or discontinue the action. Demand Requirements in the United States o Requires demand unless futile o Bases for excusing demand as futile: (1) a majority of the board has a material interest in the challenged transaction; (2) a majority of the board is dominated or controlled by the alleged wrongdoer; or (3) the challenged transaction was not the product of a valid business judgment. o But where demand is excused, the corporation may still move to dismiss the suit as not in the best interests of the corporation Why Demand? o If a shareholder has a beef against the corporation, why not provide a day in court? o A decision to sue or not to sue is ordinarily a matter of business judgment o But can a business judgment standard be applied uncritically to decisions to absolve a fellow member of the board of directors? Settling o A derivative action may not be settled except upon the approval of the court (CBCA s. 242(2)). This is to prevent blackmail and to obviate the possibility of collusive settlements between a derivative plaintiff and the corporation whereby the corporation might buy off the plaintiff to settle a nuisance suit or even a meritorious suit for less than the total damages by offering the plaintiff more than the loss to his particular investment, but less than the total loss for all shareholders. SH Ratification o The rule in Foss v. Harbottle is changed by s. 242(1) of the CBCA which provides that derivative litigation shall not be dismissed by reason only that the conduct complained of has been or may be ratified by the shareholders (this is because directors may also be shareholders) o CBCA 242 (QBCA s. 440) - An application made or an action brought or intervened in under this Part shall not be stayed or dismissed by reason only that it is shown that an alleged breach of a right or duty ... has been ...approved by the shareholders ... but evidence of approval by the shareholders may be taken into account by the court... o Ratification may, however, be taken into account by the court as a factor in determining whether the proposed litigation would be in the best interests of the corporation. The value of shareholder ratification is that it may be evidence of the fairness of the transaction or of the desirability of forgiving a breach o The only kind of shareholder approval that would likely bar a derivative plaintiff would be approval by a disinterested shareholder majority Northwest Forest Products Ltd. (1975) Jurisdiction British Columbia Facts SHs want to bring an action against the five directors of Northwest Forest for the sale of 51 Fraser Valley to Green River Log Sales. On the day of the initial sale for $200,000 Green River sold Fraser Valley assets for $300,000. Huge jump in value on the day of the sale without a reasonable explanation. Mr. Ross (SH) sent a letter to the board asking that they initiate an action (for the undervaluation of the shares of the company in the course of the first sale) but got no response. The majority of the SHs had approved the sale, however, two of the directors owned a significant number of shares and the minutes of the SH meeting do not indicate how many SH voted at the meeting, whether there was voting by proxy, etc. Issues Should the minority SH have leave to commence a derivative action? Holding Yes. Reasoning Where the minority SHs make reasonable effort to cause the directors to commence an action, the directors should act. The requirements of subs (3) of section 222 of the BC Companies Act are: 1) That the applicant had made reasonable effort to cause directors of the company to commence action 2) That the appellant is acting in good faith 3) That it is shown that it is a prima facie in the interests of the company that the action be brought; and 4) That the applicant was a member of the company at the time of the transaction giving rise to the cause of action. Comments Cashman J. stated that he would not take into account th apparent approval of the members of the company of the challenged conduct in the absence of evidence as to whether the SH majority included shares voted by the defendant directors. The inference is that the only kind of SH approval that would bar a derivative action would be approval by a disinterested shareholder majority. Derivative Actions in Quebec Past/Present o The Superior Court, in the exercise of its superintending and reforming power under Article 33 of the Code of Civil Procedure (CCP), laid down a set of conditions limiting the circumstances where this type of remedy could be used. Under Article 33, the remedy was available only to a shareholder able to show that the persons controlling the corporation had committed acts that were fraudulent, ultra vires or unlawful. Future (CBCA / January 2011) o The derivative action will be available to current or former shareholders, current or former directors or officers, or to any other person with a sufficient interest. o The applicant must seek leave of the court in order to act in the name and on behalf of the corporation or its subsidiary. o Leave may be obtained where it is established that: (i) the applicant is acting in good faith; (ii) 14 days' prior notice of the applicant's intention was given to the directors of the corporation; (iii) the board of directors of the corporation has not brought, diligently prosecuted or defended or discontinued the action; and (iv) it appears to be in the interests of the corporation or its subsidiary that the action be brought, prosecuted, defended or discontinued. o See QBCA, s. 439, 445, 446 Innovations o Once a derivative action has been authorized, the court may, if it deems necessary for purposes of the proceeding and after giving interested persons the opportunity to be heard, order communication of any relevant information or document held by the corporation or any document held or prepared for the corporation by any person, including a mandatary or service provider - See QBCA, s. 449. - No comparable provision in the CBCA o A shareholder or other holder of securities of a corporation may apply to the court for an order directing an investigation to be made of the corporation that will allow the applicant, if necessary, to 52 Tufo, Camion, Niziblian Summer 2010 bring a derivative action or a claim for oppression – See QBCA, ss. 421 et seq. (for those who do not have the means to bring a derivative action) Auerbach v. Bennett (1979) Jurisdiction NY (CA) Facts Bribes and kickbacks - directors personally involved Independent committee formed to look into these issues. Committee says we should not sue the faulty parties. S/h angry and want to bring derivative action. Issues Should the court inquire as to the independence of the committee making the decision? Holding NO basis has been shown to warrant either inquiry by the court. Reasoning Courts do not look into the decision of committee (BJR), but the process used by the committee. Was there good faith inquiry into Directors actions, or is it a sham? Courts may inquire as to the disinterested independence of the members of that committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee. Comments Gives courts substantial deference to the decisions of SLCs to terminate derivative actions Zapata v. Maldonado (1981) Jurisdiction Delaware Facts A shareholder filed a derivative action against the board of directors and certain officers of Zapata Corporation alleging breaches of fiduciary duty. In order to save themselves taxes, the directors had caused the date on which some options could be exercised to change. Since all directors were named as defendants, a committee was named four years later when two new directors were appointed. The committee moved to have the case dismissed. The court of chancery denied that request. This is an appeal from that decision. Issues Does the Special Committee have the power to cause the SH derivative action to be dismissed? Holding No. Reasoning The court should undertake a two-step determination: (a) Ask whether the committee acted independently, in good faith, and with reasonable investigation (with the burden of proof on the corporation) (b) Undertake an independent inquiry into whether the suit should be dismissed Comments - The second step is intended to thwart instances where corporate actions meet the criteria of step one, but the result does not appear to satisfy its spirit, or where corporate actions would prematurely terminate a stockholder grievance deserving of further consideration in the corporation’s interest. - The court must consider and weigh how compelling the corporate interest in dismissal is when faced with a non-frivolous lawsuit, while giving special consideration, when appropriate, to matters of law and public policy in addition to the corporation’s best interests. Questions o Should the decision of an independent committee of directors conclusively determine whether the derivative action should proceed? o Are outside directors truly “independent”? Costs in Derivative Actions o Who should bear the legal costs of the leave application for a derivative action? o The issue arises because although the basis for the derivative action is that the wrong is done to the corporation and any damages would be paid to it, the plaintiff bears the legal costs of pursuing the claim o CBCA s. 242(2) provides the court a discretionary power to order that the corporation pay the plaintiff’s legal costs prior to the final adjudication of the action o Where the company pays the costs, shareholders indirectly bear those costs as the resources are 53 directed away from other uses, either within the corporation or in the form of dividends o In some circumstances, allowing the costs permits shareholders to indirectly benefit from any damages paid to remedy wrongs to the corporation o On the other hand, there is a public policy concern that the corporation could be required to finance too many actions, frequently against its own directors and officers, out of the corporation’s assets – some of which may not have merit Interim Costs o CBCA s. 242(4); QBCA s. 443 - In an application made or an action brought or intervened in under this Part, the court may at any time order the corporation or its subsidiary to pay to the complainant interim costs, including legal fees and disbursements, but the complainant may be held accountable for such interim costs on final disposition of the application or action. o Generally, the courts have found that applications for interim funding at the time of the leave application are premature on the basis that the complainant with conduct of the derivative action should make litigation decisions bearing in mind that legal costs will not necessarily be reimbursed. o They have also held that declining to order interim costs early in the action will better discipline the complainant in respect of conduct of the action Martel There is not an equivalent to derivative action or an oppression remedy in the CCQ. Art. 33 of the Code of Civil Procedure may, however, allow courts to take the action necessary in the absence of legislative statutes. - Derivative actions are permitted ‘in the name of the corporation’ and not the individual SH name. Quebec courts are still hesitant to allow “personal claims.” - But a larger interpretation of s.33, has thus far allowed courts to “supervisory” power over moral persons could allow courts to go further. Three more recent developments have permitted such an interpretation: 1) Martineau the court found that it could intervene in cases of illegal activities or intentional harm 2) Laurent c. Buanderie Villeray Quebec courts had inherited the principles of British Courts of Equity and could tie s. 33 to s. 241 of the CBCA 3) Magil Construction: the court affirmed that it could apply s. 33 to SH rights 1. Le Code civil du -Québec et le Code de procédure civile a) Le pouvoir de révision de la Cour supérieure L'article 33 C.p.c. soumet les « personnes morales de droit privé au -Québec », ce qui inclut les compagnies, au « droit de surveillance et de réforme de la Cour supérieure ». Cet article a jus-qu'à maintenant donné ouverture à -l'action dite « dérivée », mais peut-être pourrait-il recevoir une portée encore plus vaste. 1) L'action dérivée o En principe, un actionnaire -n'a pas de recours personnel contre -l'auteur -d'un dommage causé à la compagnie. o Dans -l'affaire Silverman c. Heaps, -l'actionnaire ne peut à la fois limiter sa responsabilité en investissant dans une compagnie ET considérer comme un dommage personnel tout dommage causé à cette compagnie. Le dommage de -l'actionnaire (c'est-à-dire la baisse de valeur de ses actions) est indirect. o En -l'absence -d'un lien direct entre le tiers et -l'action-naire 110 , c'est à la compagnie elle-même, et non à ses actionnaires, -qu'il appartient de poursuivre les tiers qui lui causent un dommage 111 . o L'action dérivée (derivative), comparable à -l'action oblique du Code civil du -Québec, permet à un actionnaire de poursuivre au nom de la compagnie -l'auteur -d'un dommage, pour faire établir un tort causé à celle-ci. Le recours doit être pris par -l'actionnaire en son nom personnel, et mettre la compagnie en cause. o Ce recours sera accueilli -lorsque les personnes coupables du tort causé à la compagnie contrôlent celle-ci, et empêchent donc -qu'elle réclame la réparation du dommage. o La décision Lagacé c. Lagacé 113 en constitue le prototype. Ce jugement a établi que, pour réussir dans un cas semblable, le demandeur doit démontrer: 54 Tufo, Camion, Niziblian Summer 2010 1) sa qualité -d'actionnaire; 2) le contrôle absolu de la compagnie par les auteurs du préjudice et des irrégularités; 3) le refus -d'agir, exprès ou présumé de la part de la compagnie; 4) l'élément frauduleux ou -l'équivalent des actes reprochés. o L'action dérivée peut donc être utilisée -lorsque, par suite -d'acte frauduleux de la part de ceux qui contrôlent la compagnie, celle-ci subit un dommage o L'action dérivée peut servir non seulement à faire recouvrer certaines sommes à la compagnie mais aussi, par voie -d'injonction, à empêcher que la compagnie ne verse ces sommes. o Il nous semble toutefois que -l'action dérivée devrait être permise non seulement dans le cas où -l'auteur des irrégularités contrôle la compagnie, mais aussi -lors-qu'il est en mesure de provoquer une impasse au conseil -d'administration et -d'empêcher celui-ci de faire intenter des poursuites par la compagnie. 2) L'action personnelle o L’article 33 C.p.c. peut-il permettre une action personnelle autant -qu'une action dérivée? o A priori , les termes « surveillance et réforme » utilisés à -l' article 33 C.p.c. sont si larges que rien -n'empêche la Cour supérieure -d'accueillir une action personnelle -d'un actionnaire. La cour -n'est restreinte que par sa propre appréciation des vastes pouvoirs qui lui sont conférés, et elle pourrait fort légitimement, enhardie par la latitude dont elle dispose en vertu de la loi fédérale, décider -d'exercer ces pouvoirs de manière à protéger tout aussi efficacement les actionnaires des compagnies québécoises. C'est là -l'opinion de certains de nos auteurs, que nous partageons entièrement. o Toutefois, nos tribunaux ont toujours fait preuve, jus-qu'à présent, -d'une réticence marquée à intervenir dans les affaires internes des compagnies provinciales. o En droit administratif, les tribunaux -n'exercent leur pouvoir de révision que pour contrôler la légalité (caractère ultra vires ) des décisions prises par les organismes, et non leur opportunité (utilité, sagesse, nécessité économique, etc.). o En droit corporatif, la « règle de la majorité », fondée sur la décision Foss c. Harbottle , empêche -l'inter-ven-tion judiciaire sauf dans des circonstances exceptionnelles ( ultra vires, fraude manifeste). o Au fédéral, le législateur a écarté ces précédents en créant un recours qui vise expressément des actes injustes, et non seulement des actes illégaux, et en écartant expressément, quant à -l'exercice de ce recours, la règle de la majorité (art. 242 L.c.s.a.). o L'absence dans nos textes législatifs de dispositions similaires peut expliquer la -réticence de nos tribunaux à affranchir leur pouvoir -d'intervention en vertu de -l' article 33 C.p.c. de -l'influence de ces précédents. o Il serait néanmoins possible pour la Cour supérieure, si elle le désirait, de surmonter cette réticence, puisque celle-ci -n'a pas de support législatif et prend sa source hors du -Québec. Il suffirait -qu'un juge plus audacieux et épris -d'équité ouvre le bal. Chose certaine, la nouvelle notion -d'abus de droit, telle -qu'elle est codifiée aux articles 6, 7 et 1375 C.c.Q. , pourrait être invoquée pour justifier -l'intervention de la cour. o On peut se demander toutefois si -l' article 33 C.p.c., appliqué plus libéralement, confère à la Cour supérieure une latitude aussi grande que celle de -l' article 241 de la loi fédérale et son éventail révolutionnaire -d'ordonnances. o Quelques décisions récentes laissent entrevoir une vive lueur -d'espoir quant à - l'application de -l' article 33 C.p.c. à des situations de simple abus de droit. 1) Dans -l'arrêt Martineau, Provencher & Associés Ltée, le juge Beauregard, de la Cour -d'appel, a fait le rapprochement entre le « recours pour oppression » de la loi fédérale et les recours civils: il a reconnu que le juge saisi -d'une procédure en vertu du Code de procédure civile ne dispose pas -d'autant de pouvoirs -qu'en vertu de -l' article 241 de la loi fédérale, mais il a déclaré que ce juge peut intervenir « -lors-qu'il constate -qu'il y a eu violation -d'un droit ou abus -d'un droit », tout comme en vertu de -l' article 241 L.c.s.a. 2) Dans -l'affaire Laurent c. Buanderie Villeray Ltée, le juge Lévesque a affirmé que les cours supérieures possèdent les pouvoirs de tribunaux -d'equity en Angleterre et peuvent appliquer la théorie de -l'« attente légitime des actionnaires » retenue en liaison avec le recours de -l' article 241 de la loi fédérale pour justifier leur intervention en vertu de -l'article 33 C.p.c. Il a ajouté que les recours se rattachant à -l'obligation de loyauté et de la bonne foi et à la répression de -l'abus de droit que -l'on trouve aux articles 6, 7, 322, 324, 329, 1375, 2138 et 2218 C.c.Q. peuvent être 55 invoqués à -l'appui de -l'intervention de la Cour supérieure en vertu de -l' article 33 3) Dans -l'arrêt 9022-8818 -Québec Inc. (Magil Construction Inc.) (Syndic de), la Cour -d'appel du -Québec a réitéré que le pouvoir de surveillance et de réforme de -l' article 33 C.p.c. peut viser les situations -d'abus de droit à -l'endroit -d'un actionnaire. o À ces décisions -s'ajoute une série en expansion -constante de jugements sur des mesures préliminaires dans lesquels le tribunal déclare la porte ouverte à un « recours pour oppression » provincial, dans certains cas avec comme conclusion demandée -l'achat forcé des actions du demandeur X. SHAREHOLDER AND CORPORATE REMEDIES - THE OPPRESSION REMEDY o Protects the interests of security holders, directors, officers, and creditors from conduct by the corporation and/or its directors that is oppressive or unfairly prejudicial o Allows the court to make any order it thinks fits o Different from other remedies because it protects the interests (or reasonable expectations) of certain stakeholders, rather than rights or duties owed to the corporation o A unique creation of Canadian legislatures and courts that provides “the broadest, most comprehensive and most open-ended shareholder remedy in the common law world Common Law Who Can Seek the Remedy? CBCA s. 238 “Complainant” means: (a) A registered holder or beneficial owner, and a former registered holder or beneficial owner, of a security of a corporation or any of its affiliates (b) A director or an officer or a former director or officer of a corporation or any of its affiliates (c) The Director, or (d) Any other person who, in the discretion of a court, is a proper person to make an application under this Part. Application of the Remedy CBCA s. 241 (1) A complainant may apply to a court for an order under this section. (2) If, on an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates a) any act or omission of the corporation or any of its affiliates effects a result b) the business or affairs of the corporation or any of its affiliates are or have been carried on or conducted in a manner, or c) the powers of the directors of the corporation or any of its affiliates are or have been exercised in a manner that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer, the court may make an order to rectify the matters complained of. (3) In connection with an application under this section, the court may make any interim or final order it thinks fit. Civil Law Oppression Remedy in Quebec 56 Tufo, Camion, Niziblian Summer 2010 o No real oppression remedy available under the Quebec Companies Act o However, under s. 450 QBCA, a shareholder, director or officer, and in the case of a corporation that is a reporting issuer, any holder of securities, including a (former or current) holder of debentures or bonds, may apply to the court for a curative order where 1) Any act or omission of the corporation effects or threatens to effect a result, 2) The business or affairs of the corporation have been, are or are threatened to be conducted in a manner, or 3) The powers of the board of directors of the corporation have been, are or are threatened to be exercised in a manner that is or could be "oppressive" or "unfairly prejudicial" to such person. How the QBCA Oppression Remedy Differs from the CBCA o Oppression remedy available where conduct by a corporation or its directors could be oppressive or unfairly prejudicial - possibility of oppressive conduct not sanctioned by CBCA o Creditors of a corporation governed by the QBCA, with the exception of holders of debt securities of a reporting issuer, cannot seek an oppression remedy o The QBCA permits the court to intervene in the presence of oppressive conduct or unfair prejudice while the CBCA permits intervention where there is an "unfair disregard" of interests (this is the lowest threshold) Compared to Derivative Actions o Derivative Actions - Require leave - Court exercises a statutory supervisory jurisdiction over the derivative action that enables it to issue orders concerning issues such as the manner in which the action is conducted, which party will have conduct of the action, and who will receive any damages awarded in the action. - Damages go to the corporation o Oppression Remedy - No leave required - Court has no statutory power to intervene in the conduct of the application, except for court approval of any settlement, discontinuance, or abandonment of an oppression remedy application (can do this for derivative action too) - Claimant can pursue a claim for personal compensation for harm to the complainant’s interests from the oppressive actions Note: If the harm is clearly to the corporation, then it might make more sense to go ahead with a derivative action, but given the leave requirement, it is still good to have the oppression remedy in one’s back pocket. Is the Oppression Remedy Necessary? o In a number of cases where the courts have found that directors were acting in good faith in the corporation’s best interests (i.e. in compliance with their duty of loyalty) they have also found that the effects of their actions on the complainant’s interests gave rise to a successful oppression claim (although they did not find against the directors personally) o It is a very attractive tool for fashioning creative solutions to situations in which relations between a small group of shareholders have broken down o Used because courts are reluctant to find that majority SHs owe fiduciary duties to minority SHs o More recently, debt holders, creditors, and employees have looked to the remedy as a vehicle to advance claims against shareholders or the corporation Can an Employee Officer Bring an Oppression Claim? Clitheroe v. Hydro One (2001) Jurisdiction Ontario 57 Facts Employee and Director of company loses CEO job due to Legislature adopting new legislation reducing governmental expenses. Issues Does plaintiff have standing to bring an oppression remedy claim? Holding No, the termination was not part of an oppressive pattern. Reasoning The oppression remedy is meant to redress oppressive conduct in relation to the claimant’s position as a security holder, creditor, director or officer of a corporation. It does not operate to provide a remedy to employees, UNLESS the termination is part of a pattern of oppressive conduct. There is another remedy (wrongful dismissal claim). Comments The oppression remedy protects expectations (here of employment). A “Proper Person” to Bring the Application o The basic formula for establishing unfair prejudice or unfair disregard of the interests of the creditor should reflect as a goal the desire to seek to balance protection of the creditor’s interest against the policy of preserving freedom of action for management and the right of the corporation to deal with a creditor in a way that may be to the prejudice of the interests of the creditor or that may disregard those interests so long as the prejudice or disregard is not unfair. o The oppression remedy would be available if the act or conduct of the directors or management of the corporation which is complained of amounted to using the corporation as a vehicle for committing fraud upon a creditor First Edmonton Place Ltd. v. 315888 Alberta Ltd. (1988) Jurisdiction Alberta Facts A landlord (FED) provided a package of inducements to get a company controlled by three lawyers to sign a ten-year lease. The package included an 18-month rent-free period, a leasehold improvement allowance, and a cash payment. The lawyers distributed the cash amongst themselves, made use of the space during the rent-free period, and then for a further three months without the company having entered into a formal lease. They then vacated the premises and no rent was paid. FED sought leave to bring an oppression action under s. 234 of the Alberta Business Corporations Act or a derivative action under s. 232, alleging that the actions of the lawyers as directors of the company were unfairly prejudicial to, or unfairly disregarded, the landlord’s interests. Issues Can FED bring an oppression remedy claim under s. 234? Can FED bring an action under s.232? Holding No. Yes. Reasoning S. 234 can be used to protect the interests of a creditor. The remedy would be available if the conduct of the directors or management of the corporation had amounted to using the corporation as a vehicle for committing fraud upon a creditor. There are two situations in which justice and equity would allow a creditor to be regarded as a proper person: 1) The conduct of the directors amounts to fraud 2) The conduct breached the underlying expectations of the applicant arising from the circumstances in which the applicant’s relationship with the corporation arose (but such expectations must be reasonable). o In this case, there is no evidence showing that there was an expectation on the part of the lessor that the lessee corporation would retain the funds in its hands for any set period of time. Nor is there evidence that there was an expectation that the lessee corporation would grant a lease for a term of 10 years or any other term beyond the rent- free period. There is no evidence of inequality of bargaining power. o The applicant must have had an interest as a creditor at the time that the acts complained of occurred. At that time, however, there wasn’t any rent due. The word “creditor” in s. 58 Tufo, Camion, Niziblian Summer 2010 234 does not include a lessor in respect of rent not owing at the time of the acts complained of. S.232 There is evidence that the cash inducement money was not used for the purposes of the corporation and that its use might have been a fraud upon the corporation. If it was a fraud upon the corporation, and if the corporation was entitled to recover the money, the applicant may have a genuine interest in advancing the claim to such recovery because the corporation might be liable in damages to the applicant. The applicant is therefore a proper person to make an application under s. 232. Comment A statutory representative action is the minority s/h sword to the majority’s twin shields of corporate personality and majority rule! Downtown Eatery Ltd. v. Ontario (2001) Jurisdiction Ontario Facts Grad and Grossman owned and operated two nightclubs.One day, Grad offered the appellant, Alouche, a position as manager of one of the nightclubs. The contract provided that Alouche would receive the health care and insurance benefits available in the “sister’s organization” which was not identified by name. He received his paychecks from Best Beaver, a company controlled by Grad and Grossman. He was eventually dismissed and commenced a successful wrongful dismissal claim. However, Grad and Grossman had since reorganized their corporate entities and Best Beaver was no longer operating at the time that Alouche became entitled to receive his damages. Issues Did the trial judge err in failing to find that the conduct of Grad and Grossman was oppressive or unfairly prejudicial? Holding Yes Reasoning The trial judge had accepted Grad and Grossman’s statement that the corporate reorganization did not take place so as to preclude Alouche from obtaining his damages in part because it had taken place before Alouche had obtained the status of a creditor. Oppressive conduct that causes harm to a complainant need not be undertaken with the intention of harming the complainant. Provided that the complainant has a reasonable expectation that a company’s affairs will be conducted with a view to protecting his interests, the conduct complained of need not be undertaken with a view to harming the plaintiff. What the OBCA prescribes is “any act or omission” on the part of the corporation which “effects” a result that is unfairly prejudicial to or that unfairly disregards the interests of the complainant. When Best Beaver went out of business it was profitable and could have satisfied the claims arising from employment contracts. Moreover, Grad and Grossman knew that Alouche’s claim could be successful. Comments Note that just like FED, Alouche was not a creditor at the time of the action complained of. But the judge treats this situation differently here. Note: Instead of using OR, they could have simply pierced the corporate veil. This way they coud have gone after the personal assets of the directors or the other companies they held. West v. Edison Packaging Machinery Ltd. (1993) Jurisdiction Ontario Facts The applicants were management employees of Edison who were dismissed. Prior to the dismissal, they had purchased shares in Edison and were told that a SH agreement would be executed and that Edison would buy back the shares when an employee left the company. A shareholder agreement was not executed and after the dismissal, Edison refused to buy back the shares. The applicants claim that Edison had engendered a reasonable expectation that a shareholders agreement would be executed within six months of the purchase of the shares, 59 and that the shares would be bought back if they left Edison. Issues Are the applicants (although employees) proper persons to bring the claim? Holding Yes. Reasoning The course of conduct which the applicants maintain gave rise to their reasonable expectations covers a period of several months, both preceding and following their purchase of shares. This is sufficient to qualify them as “complainants” under the Act. Comments Judge refers to the test laid out in FED (two conditions under which a creditor can bring a claim) and says that he sees no reason why this reasoning should be limited to creditors. Questions 1. In your view, were the plaintiffs really complaining in their capacity as shareholders or were they complaining in their capacity as former management employees? Put another way, was the complaint one about their “legitimate expectations” as shareholders or as employees who had agreed that as part of the employment relationship they would purchase shares that were to be repurchased upon the termination of their employment? 2. The definition of “complainant” is open-ended and employees will quite often be able to characterize themselves as being not only employees but also shareholders as in West v. Edson, or creditors as in Downtown Eatery. Should an employee have to proceed in this rather circuitous manner or should the oppression remedy be amended to simply say that an employee may bring an application under the oppression remedy? Would this open the floodgates to endless claims by employees? Should business corporations statutes avoid becoming a vehicle for dealing with issues that you might more typically see raised through labour or employment law, or would this merely be an exercise in reinforcing an unnecessarily artificial distinction? 3. The “proper person” issue is one means through which the courts may express their views about which kinds of relationships and what kinds of acts by the corporation can be the subject of an oppression remedy application. What factors do you think ought to make the courts reluctant to construct a high threshold for being considered a “proper person”? BCE v. 1976 Debentureholders (2008) Jurisdiction SCC Facts At issue is a plan that contemplates the purchase of the shares of BCE Inc. by a consortium of purchasers (the “Purchaser”) by way of a leveraged buyout. An auction process was held and offers submitted by three groups. All three offers contemplated the addition of substantial new debt for which Bell Canada, a wholly owned subsidiary of BCE, would be liable. BCE’s board of directors found that the Purchaser’s offer was in the best interests of BCE and BCE’s shareholders. The plan of arrangement was approved by 97.93 percent of BCE’s shareholders, but was opposed by a group of financial and other institutions that held debentures issued by Bell Canada. The debentureholders sought relief under the oppression remedy under s. 241 of the CBCA. They also alleged that the arrangement was not “fair and reasonable” and opposed court approval of the arrangement under s. 192 of the CBCA. Their complaints was that, upon the completion of the arrangement, the short-term trading value of their debentures would decline by an average of 20 percent and could lose investment grade status. The Quebec Superior Court approved the arrangement as fair, the Court of Appeal set aside that decision, finding that the arrangement had not been fair. It held that the directors had not only the duty to ensure that the debentureholders’ contractual rights would be respected, but also to consider their reasonable expectations (i.e. the adverse impact on the debentureholders’ economic interests). Since the requirements of s. 192 of the CBCA were not met, the court found it unnecessary to consider the oppression claim. BCE and Bell Canada appealed the overturning of the trial judge’s approval of the plan of arrangement, and the debentureholders cross-appealed the dismissal of the claims for oppression. Issues 1. Oppression remedy (s. 241) 60 Tufo, Camion, Niziblian Summer 2010 (1) Does the evidence support the reasonable expectation asserted by the claimant? NO (2) Does the evidence establish that the reasonable expectation was violated by conduct falling within the terms “oppression”, “unfair prejudice” or “unfair disregard” of a relevant interest? NO 2. Approval process of the plan of arrangement (s. 192) (1) Have the statutory procedures been met? Not relevant, but yes. (2) Has the application been put forth in good faith? Not very relevant, but yes. (3) Is the arrangement “fair and reasonable”? YES Holding Appeal allowed, cross-appeal dismissed. Ratio The s. 241 oppression action and the s. 192 requirement for court approval of a change to the corporate structure are different types of proceedings, engaging different inquiries. The Court of Appeal’s decision rested on an approach that erroneously combined the substance of the s. 241 oppression remedy with the onus of the s. 192 arrangement approval process, resulting in a conclusion that could not have been sustained under either provision, read on its own terms.   1. The Section 241 Oppression Remedy The oppression remedy focuses on harm to the legal and equitable interests of a wide range of stakeholders affected by oppressive acts of a corporation or its directors. This remedy gives a court a broad jurisdiction to enforce not just what is legal but what is fair. Oppression is also fact specific: what is just and equitable is judged by the reasonable expectations of the stakeholders in the context and in regard to the relationships at play.  [58-59] In assessing a claim of oppression, a court must answer two questions: (1) Does the evidence support the reasonable expectation asserted by the claimant? (2) Does the evidence establish that the reasonable expectation was violated by conduct falling within the terms “oppression”, “unfair prejudice” or “unfair disregard” of a relevant interest? For the first question, useful factors from the case law in determining whether a reasonable expectation exists include: general commercial practice; the nature of the corporation; the relationship between the parties; past practice; steps the claimant could have taken to protect itself; representations and agreements; and the fair resolution of conflicting interests between corporate stakeholders. For the second question, a claimant must show that the failure to meet the reasonable expectation involved unfair conduct and prejudicial consequences under s. 241.     Where conflicting interests arise, it falls to the directors of the corporation to resolve them in accordance with their fiduciary duty to act in the best interests of the corporation. There are no absolute rules and no principle that one set of interests should prevail over another. In each case, the question is whether, in all the circumstances, the directors acted in the best interests of the corporation. Where it is impossible to please all stakeholders, it will be irrelevant that the directors rejected alternative transactions that were no more beneficial than the chosen one. [81-83] Here, the debentureholders did not establish that they had a reasonable expectation that the directors of BCE would protect their economic interests by putting forth a plan of arrangement that would maintain the investment grade trading value of their debentures. The trial judge concluded that this expectation was not made out on the evidence, given the overall context of the relationship, the nature of the corporation, its situation as the target of a bidding war, the fact that the claimants could have protected themselves against reductions in market value by negotiating appropriate contractual terms, and that any statements by Bell Canada suggesting a commitment to retain investment grade ratings for the debentures were accompanied by warnings precluding such expectations. The trial judge recognized that the content of the directors’ fiduciary duty to act in the best interests of the corporation was affected by 61 the various interests at stake in the context of the auction process, and that they might have to approve transactions that were in the best interests of the corporation but which benefited some groups at the expense of others. All three competing bids required Bell Canada to assume additional debt. Under the business judgment rule, deference should be accorded to the business decisions of directors acting in good faith in performing the functions they were elected to perform. [96-100] The debentureholders had also argued that they had a reasonable expectation that the directors would consider their economic interests in maintaining the trading value of the debentures. It is apparent that the directors considered the interests of debentureholders, and concluded that while the contractual terms of the debentures would be honoured, no further commitments could be made. This fulfilled the duty of the directors to consider the debentureholders’ interests and did not amount to “unfair disregard” of the interests of debentureholders. What the claimants contend is an expectation that the directors would take positive steps to restructure the purchase in a way that would provide a satisfactory price to shareholders and preserve the high market value of the debentures. There was no evidence that it was reasonable to suppose this could be achieved, since all three bids involved a substantial increase in Bell Canada’s debt. Commercial practice and reality also undermine their claim. Leveraged buyouts are not unusual or unforeseeable, and the debentureholders could have negotiated protections in their contracts. No representations had been made to debentureholders upon which they could reasonably rely.   [104-106] [108-110] With respect to the duty on directors to resolve the conflicting interests of stakeholders in a fair manner that reflected the best interests of the corporation, the corporation’s best interests arguably favoured acceptance of the offer at the time. The trial judge accepted the evidence that Bell Canada needed to undertake significant changes to be successful, and the momentum of the market made a buyout inevitable. Considering all the relevant factors, the debentureholders failed to establish a reasonable expectation that could give rise to a claim for oppression. [111-113] 2. The Section 192 Approval Process The s. 192 approval process is generally applicable to change of control transactions where the arrangement is sponsored by the directors of the target company and the goal is to require some or all shareholders to surrender their shares. The approval process focuses on whether the arrangement, viewed objectively, is fair and reasonable. Its purpose is to permit major changes in corporate structure to be made while ensuring that individuals whose rights may be affected are treated fairly, and its spirit is to achieve a fair balance between conflicting interests. In seeking court approval of an arrangement, the onus is on the corporation to establish that (1) the statutory procedures have been met; (2) the application has been put forth in good faith; and (3) the arrangement is “fair and reasonable”.     To approve a plan of arrangement as fair and reasonable, courts must be satisfied that (a) the arrangement has a valid business purpose, and (b) the objections of those whose legal rights are being arranged are being resolved in a fair and balanced way. Whether these requirements are met is determined by taking into account a variety of relevant factors, including the necessity of the arrangement to the corporation’s continued existence, the approval, if any, of a majority of shareholders and other security holders entitled to vote, and the proportionality of the impact on affected groups. Where there has been no vote, courts may consider whether an intelligent and honest business person, as a member of the class concerned and acting in his or her own interest, might reasonably approve of the plan. Courts must focus on the terms and impact of the arrangement itself, rather than the process by which it was reached, and must be satisfied that the burden imposed by the arrangement on security holders is justified by the interests of the corporation. Courts on a s. 192 62 Tufo, Camion, Niziblian Summer 2010 application should refrain from substituting their views of the “best” arrangement, but should not surrender their duty to scrutinize the arrangement.     [154-155] The purpose of s. 192 suggests that only security holders whose legal rights stand to be affected by the proposal are envisioned. It is the fact that the corporation is permitted to alter individual rights that places the matter beyond the power of the directors and creates the need for shareholder and court approval. However, in some circumstances, interests that are not strictly legal could be considered. The fact that a group whose legal rights are left intact faces a reduction in the trading value of its securities generally does not, without more, constitute a circumstance where non-legal interests should be considered on a s. 192 application. [133-135] Here, the debentureholders no longer argue that the arrangement lacks a valid business purpose. The debate focuses on whether the objections of those whose rights are being arranged were resolved in a fair and balanced way. Since only their economic interests were affected by the proposed transaction, not their legal rights, and since they did not fall within an exceptional situation where non-legal interests should be considered under s. 192, the debentureholders did not constitute an affected class under s. 192, and the trial judge was correct in concluding that they should not be permitted to veto almost 98 percent of the shareholders simply because the trading value of their securities would be affected. The arrangement did not fundamentally alter the debentureholders’ rights, as the investment and return they contracted for remained intact. It was well known that alteration in debt load could cause fluctuations in the trading value of the debentures, and yet the debentureholders had not contracted against this contingency. It was clear to the judge that the continuance of the corporation required acceptance of an arrangement that would entail increased debt and debt guarantees by Bell Canada. Recognizing that there is no such thing as a perfect arrangement, the trial judge correctly concluded that the arrangement had been shown to be fair and reasonable.   [163-164] Note: o Oppression is an equitable remedy. It seeks to ensure fairness — what is “just and equitable”. o Oppression is fact-specific. What is just and equitable is judged by the reasonable expectations of the stakeholders in the context and in regard to the relationships at play. Conduct that may be oppressive in one situation may not be in another o The concept of reasonable expectations is objective and contextual. The actual expectation of a particular stakeholder is not conclusive. In the context of whether it would be “just and equitable” to grant a remedy, the question is whether the expectation is reasonable having regard to the facts of the specific case, the relationships at issue, and the entire context, including the fact that there may be conflicting claims and expectations o Even if reasonable, not every unmet expectation gives rise to a claim under s. 241. The section requires that the conduct complained of amount to “oppression”, “unfair prejudice” or “unfair disregard” of relevant interests. o Oppression carries the sense of conduct that is coercive and abusive, and suggests bad faith o Unfair prejudice may admit of a less culpable state of mind that nevertheless has unfair consequences. o Unfair disregard of interests extends the remedy to ignoring an interest as being of no importance, contrary to the stakeholders’ reasonable expectations. What is a Reasonable Expectation? Factors that emerge from the case law that include: general commercial practice; the nature of the corporation; the relationship between the parties; past practice; steps the claimant could have taken to protect itself; representations and agreements; and the fair resolution of conflicting interests between corporate stakeholders. 63 Commercial Practice Commercial practice plays a significant role in forming the reasonable expectations of the parties. A departure from normal business practices that has the effect of undermining or frustrating the complainant’s exercise of his or her legal rights will generally (although not inevitably) give rise to a remedy. The Nature of the Corporation The size, nature and structure of the corporation are relevant factors in assessing reasonable expectations. Courts may accord more latitude to the directors of a small, closely held corporation to deviate from strict formalities than to the directors of a larger public company. Relationships Reasonable expectations may emerge from the personal relationships between the claimant and other corporate actors. Relationships between shareholders based on ties of family or friendship may be governed by different standards than relationships between arm’s length shareholders in a widely held corporation. Past Practice Past practice may create reasonable expectations, especially among shareholders of a closely held corporation on matters relating to participation of shareholders in the corporation’s profits and governance. It is important to note that practices and expectations can change over time. Where valid commercial reasons exist for the change and the change does not undermine the complainant’s rights, there can be no reasonable expectation that directors will resist a departure from past practice. Preventive Steps In determining whether a stakeholder expectation is reasonable, the court may consider whether the claimant could have taken steps to protect itself against the prejudice it claims to have suffered. Thus it may be relevant to inquire whether a secured creditor claiming oppressive conduct could have negotiated protections against the prejudice suffered. Representations and Agreements Shareholder agreements may be viewed as reflecting the reasonable expectations of the parties. Reasonable expectations may also be affected by representations made to stakeholders or to the public in promotional material or in a company’s public statements and the shared expectations about the way in which a public company should be run. Fair Resolution of Conflicting Interests Conflicts may arise between the interests of corporate stakeholders inter se and between stakeholders and the corporation. Where the conflict involves the interests of the corporation, it falls to the directors of the corporation to resolve them in accordance with their fiduciary duty to act in the best interests of the corporation, viewed as a good corporate citizen. Note: To determine shared expectations, one can look at the articles of incorporation, the corporate culture The cases on oppression confirm that the duty of the directors to act in the best interests of the corporation comprehends a duty to treat individual stakeholders affected by corporate actions equitably and fairly. There is no principle that one set of interests — for example the interests of shareholders — should prevail over another set of interests. Scope of the Oppression Remedy Ferguson v. Imax (1983) Jurisdiction Ontario Facts The appellant seeks relief under CBCA s. 234, alleging that Imax Corp. attempted to reorganize its capital by a special resolution amending its articles, thus disregarding her interests as a security holder. She seeks an injunction to restrain the company from holding a special meeting to vote on the resolution. 64 Tufo, Camion, Niziblian Summer 2010 Shares of the company had been issued and divided among three couples. Each husband received 700 shares and wife 700 class B shares (non-redeemable & non-voting unless the company failed to pay a 5c dividend for two consecutive years). The class B shares entitled the holder to receive dividends in priority over the common shares. Unlike the two other wives, the appellant worked hard in the company’s interest and was one of its founders. She was not compensated for her work and efforts. In 1974, the appellant and her husband divorced. That year, the company made $72,000$ in profits, and up to $210,000$ in the following years. Mr. Ferguson did everything to evince his ex-wife from her SH status. During their separation, he tried to have the shares transferred. He then put pressure on the company not to declare dividends, which his partners accepted. The contested resolution aimed at converting all of the class B shares into class A shares, that is, non-voting and limited to 9% cumulated dividends for five years, after what the company would redeem them at the fixed price of $175 per share. There was no reason explaining the resolution. Issues Can the SHs of a closed-held corporation vote a resolution to convert class B shares into class A shares, thereby forcing the holders of such shares to eventually sell them to the corporation? Holding No. Reasoning o [Goldex Mines Letd v. Revill et al, 1974] “The principle that the majority governs in corporate affaires is fundamental, but its corollary is also important – that the majority must act fairly and honestly.” o Case law establishes that each case turns on its own facts: what’s oppressive or unfairly prejudicial varies from case to case. o S. 234 must be interpreted broadly when considering the interests of minorities. When dealing with a close corporation, the court may consider the relationship between the SHs and not simply legal rights as such. o In addition, the court must consider the bona fides of the corporate transaction in question to determine whether the act of the corporation or directors effects an oppressive result. o The resolution authorizing the change in the capital of the company is the culminating event in a lengthy course of oppressive and unfairly prejudicial conduct to the appellant. The company has not acted bona fide in exercising its power to amend its articles. o The appellant is the only one affected by the resolution. She cannot be considered as a newbie minority: the appellant’s work in the company is important. Comments The court contrasts the position of Ms. Ferguson as the holder of Class B shares with that of someone who might have purchased a similar number of Class B shares after the corporation became established and implies that the latter would not be entitled to an oppression remedy claim with respect to a similar resolution. Naneff v. Con-Crete Holdings (1993) Jurisdiction Ontario Facts Alexander Naneff was one of two sons of Nick Naneff, a successful entrepreneur in the concrete industry. Nick wanted his two sons to be involved in his business and implemented an estate freeze that gave each 50% of the common shares of the company. He retained control through special voting preferred shares. Both sons were directors and officers involved in running the business. Alex’s lifestyle worried his family and when he became involved with a woman they did not approve of, the rest of the family excluded him from business. He was terminated from his employment without any severance payments. His father and brother caused the family corporation to cease the payment of bonuses (which was how the two brothers were given access to the profits) and instead began giving salaries to themselves. They also refused to pay Alex any amounts from his past bonuses, which had been returned to the corporations as SH loans. Finally, when dividends were declared, they were declared only on the shares held by the father and brother. Alex sought relief under the 65 oppression remedy. Issues Is Alex entitled to the oppression remedy? Holding General Division: Yes. / Court of Appeal: No. Reasoning General Division o OBCA s. 248(2) applies [241.3 now]. When an oppressive conduct is found, the court may make any order it thinks fit.” o Evidence of bad faith or want of probity is not essential to a finding of oppression. o The emphasis in the case law is rather on SHs’ reasonable expectations. These are not an individual wish list, but expectations which could or should have been considered as part of the compact of the SHs. o Lord Wilberforce in Ebrahimi: “The foundation of it all lies in the words “just and equitable”… the words are a recognition of the fact that a limited company is more than a mere judicial entity… that there is room in company law for recognition of the fact that behind it… there are individuals, with rights, expectations, and obligations inter se which are not necessarily submerged in the company structure.” o The two brothers were led to believe that they would eventually have complete ownership and control of the Rainbow Group of companies of their father. They took a greater and greater part in the running of the companies. o Alex holds 50% of the shares. It is clear that the intention of his father was that his sons would have full ownership and control of the companies. o The “gift” cannot be reversed at this stage at the whim of the father in order to discipline a disappointing son. o Alex is a director and has been an officer, on a full-time basis for his entire adult life. He was viewed and respected by third parties as an effective owner o His removal from his position as an officer and his exclusion from the day-to-day business and participation as a director constitutes an “oppression” within the meaning of s. 248 OBCA. o Alex’s worrying conduct (a.k.a. Wendy) was not linked to his positions as an officer and director; the intention of his parents was to correct him on a personal rather than professional basis; his lifestyle did not impair his professional performances Court of Appeal (Reversed) o The determination of a reasonable expectation is important. o Alex must have understood that his father, until his death or retirement, would retain control of the company. He could not have expected to control the company while his father was alive and active. o He could have expected to inherit control of the company only to the extent that his father would continue to be bountiful to him. He could not expect that bounty to continue if his father, for whatever reason, no longer considered him a good son. o Granting the oppression remedy is punitive to Nick Naneff. It puts him in a position equal to that of Alex even though he had devoted 40 years of his life to building up his business. o In addition, granting the remedy protects Alex’s interests as son AND as shareholder. Note: In “Dealing With Unfairness: Some Observations on the Role of the Courts in Designing a Fair Solution,” Raymon Crete suggests that in dealing with an oppression remedy case involving a closely held corporation, courts should adopt a hypothetical bargaining model in attempting to decide whether a remedy should be granted and in what form. In a hypothetical bargain model, the court attempts to construct the terms of a bargain between the participants concerning the contentious matters under ideal conditions. This understanding of the oppression remedy is consistent with the nexus of contracts theory of the corporation in which the oppression remedy serves to fill in the gaps in actual agreements reached when a corporation was formed. This approach may be effective when a corporation is small but becomes less meaningful when 66 Tufo, Camion, Niziblian Summer 2010 dealing with large corporations (separation of share ownership and the control of the corporation). Bad Faith or Unfair Effects? Question: Must a shareholder seeking an oppression remedy in a publicly traded corporation prove that the directors are acting in bad faith or for improper purposes? Brant Investments v. KeepRite Inc. (1991) Jurisdiction Ontario (CA) Facts KeepRite, a company involved in the cooling business, was facing financial problems. Its management proposed that the company acquire assets from a subsidiary of KeepRite’s majority SH, Inter-City Gas Corporation (ICG), having to do with the heating business. The proposal was to combine heating and cooling to diversify and stabilize the company’s revenues. It was also a strategy to make KeepRite more attractive on the equity market. Because the purchase was from a related company, KeepRite set up an independent committee to review the proposal (made up of directors independent from management in KeepRite and ICG). The committee recommended the adoption of the proposal. A SH meeting was called to approve the creation of new shares. Some minority SH were unhappy with the proposed transaction. They voted against and dissented under the appraisal remedy. The dissenting minority refused KeepRite’s offer for their shares and so KeepRite applied to the Supreme Court of ON to fix the fair value of the shares. Meanwhile, the dissenting SH brought an oppression action under CBCA. At trial, the oppression claim was dismissed. The SHs appealed. Issues 1) Does the board of directors or an independent committee owe a fiduciary duty to minority SH? NO 2) Does a finding of oppression require a want of probity, or is the result sufficient? Result suffices. 3) When there is a benefit to the majority, with a corresponding detriment incurred to the minority, and the minority dissented, does the burden of proof that there is no oppression rest on the majority? NO 4) Can the courts use the Business Judgment rule where the rule dictates deference to the decisions of the very party under scrutiny? YES if the decisions were made honestly (no bad faith). Holding Appeal dismissed. 67 Reasoning 1) Fiduciary duty - Does the board of directors or an independent committee owe a fiduciary duty to minority SH? - Any argument broadening the categories of relationships in the corporate context are inappropriate, considering the coming into force of CBCA (s. 234) and OBCA (s. 247.2). To import the concept of fiduciary duty into s.234 would complicate its interpretation and application and be inimical to the statutory fiduciary duty imposed upon directors in s. 122.1 (used to be 117.1) - To impose on directors and officers a fiduciary duty to the corporation as well as to individual groups of SH could place directors in a position of irreconcilable conflict, particularly when the corporation is faced with adverse economic conditions. [contradicted in BCE] - Such a duty is imposed only where there is a relationship based on trust. 2) Bona Fides - Does a finding of oppression require a want of probity (conduct inconsistent with good faith), or is the result sufficient? - Mixed judicial opinion; there is no statutory requirement of bad faith to find oppression. There has been a change in UK law, from conduct to mere result; the statutory requirement of an oppressive manner of conducting the affairs of a corporation, became a requirement that the conduct be “unfairly prejudicial to the interests of some part of its members”. - Unfairly prejudicial has been expressed through an objective rather than subjective test - Conduct may be considered in order to show bad faith, but it is not required - CBCA s. 234.2 makes specific reference to a) the wrongfulness of the result of corporate conduct [now s. 241], b) to the manner in which the business affairs are carried on, and c) to the manner in which the powers of the directors have been used. o So, evidence of bad faith is unnecessary o The difficult question is whether the rights of minorities have been unfairly disregarded. o It may happen that some acts made in good faith lead to unfair results o In Low v. Ascot Jockey Club, “what is at issue is the effect of the conduct or acts complained of. Nothing is to be gained by importing notions of malice into this branch of the law… malice or an intent to do harm is not a necessary ingredient.” 3) Onus of proof When there is a benefit to the majority, with a corresponding detriment incurred to the minority, does the burden of proof that there is no oppression rest on the majority? It is alleged that the majority must prove that a) the transaction was at least as advantageous to the company and SHs as any other alternative; b) that no undue pressure was applied to the company, its officers, directors, to accept the transaction; c) that the transaction and the process leading to its acceptance were intrinsically fair. Totally rejected by the court since no authority cited! Independent committee does not pose any problem according to the judge. 4) Business Judgment Rule and the oppression remedy Can the court use BJR where the rule dictates deference to the decisions of the very party under scrutiny? - The underlying justification of the rule still applies: the judge is no expert and cannot substitute his views for those of the directors - Business decisions made honestly should not be subject to examination (the judge makes several arguments to show that the decisions were made honestly) 68 Tufo, Camion, Niziblian Summer 2010 Business Judgment and the Oppression Remedy o Although the minority shareholder must be protected from unfair treatment under the oppression remedy, the court ought not to usurp the function of the board of directors in managing the company, nor should it eliminate or supplant the legitimate exercise of control by the majority. o Business decisions, honestly made, should not be subjected to microscopic examination. There should be no interference simply because a decision is unpopular with the minority. Questions o Do you think that McKinlay JA’s understanding of how the oppression remedy should interact with a board’s fiduciary duties to the corporation is satisfactory? Why would imposing a fiduciary duty on a majority shareholder with respect to minority shareholders put a board of directors in a position of conflict with respect to its obligation to act in the best interests of the company? Does the answer to this question depend on one’s vision of the corporation: that is, one’s views about whether the board is acting as agent of the shareholders/“owners” or whether its job is to foster the interests of a broader range of constituencies? Does the interpretation of the directors’ statutory fiduciary duty in Peoples being owed to the corporation rather than shareholders assist in defining the vision of the corporation in Canadian corporate law? o Would imposing a fiduciary duty on majority shareholders with respect to minority shareholders really give rise to an obligation that was any different from the obligation that has effectively been imposed through the oppression remedy? McKinlay JA thought that there would be a difference and it would appear that he was after a legal structure that would give the board room to manoeuvre as it considers how best to deal with competing interests in the corporation. Has he crafted a structure that is compatible with the business judgment rule? Note: Does the fiduciary duty impose a higher duty than that under the oppression remedy? Does it require more than simply taking someone’s interest in consideration and actually going so far as to advance that group’s interests or to make them foremost? (In the US, the fiduciary duty means not thwarting their interests). Conduct Giving Rise to the Oppression Remedy o Only some kinds of conduct may be oppressive, but all such conduct is likely to meet the standard of "unfairly prejudicial" or "unfairly disregards," so the real threshold for relief is "unfair disregard," the lowest of the three standards o Unfair prejudice” is generally seen as involving conduct less offensive than “oppression”. - Examples include squeezing out a minority shareholder, failing to disclose related party transactions, changing corporate structure to drastically alter debt ratios, adopting a “poison pill” to prevent a takeover bid, paying dividends without a formal declaration, preferring some shareholders with management fees and paying directors’ fees higher than the industry norm. Indicia of Oppressive Conduct o In Arthur v. Signum Communications Ltd., the following non-exhaustive list was set out: - Lack of a valid corporate purpose for the transaction (e.g., paying excessive salaries, directors taking corporate assets); - Failure on the part of the corporation and its controlling shareholders to take reasonable steps to simulate an arm's-length transaction - Lack of good faith on the part of the directors of the corporation - Discrimination among shareholders, with the effect of benefiting the majority shareholder to the exclusion or the detriment of minority shareholders - Lack of adequate and appropriate disclosure of material information to minority shareholders - A plan or design to eliminate a minority shareholder Derivative or Oppression? o Previously, it was thought that where an injury was an injury to the corporation, and any injury to the shareholder was only incidental to the corporate injury (such as where a breach of fiduciary duty was alleged) relief could be claimed only by the corporation itself or by a shareholder with leave of the court in a derivative action. 69 o In BCE, the Supreme Court confirmed that there is no barrier to bringing an oppression claim in relation to actions that are a breach of fiduciary duty. In fact, a director's fiduciary duty and other duties are relevant to a finding of oppression. In BCE, the Supreme Court made clear that compliance with the fiduciary duty is a reasonable expectation, and, consequently, that a breach of fiduciary duty can be invoked by a complainant in support of an oppression claim. o The Court also clarified that sometimes the impact of a fiduciary breach contrary to reasonable expectations may not rise to the standards set in the oppression provisions, but at the same time, compliance with the fiduciary duty does not mean that no oppression may be found Remedies o The court may make "any interim or final order it thinks fit: CBCA, s. 241 o This can include share purchases (purchase by a corporation or a majority shareholder of the applicant's shares); liquidation and dissolution; orders against SHs at the request of creditors; compliance orders; amendment of by-laws and the replacement of management, appointment of receivers, amendment of shareholder agreements XI. CORPORATE GOVERNANCE o Corporate governance is the structure by which corporate decisions are made so that capital can be raised cost-effectively, assets are used in the efficient generation of wealth and with a view to the sustainability of the corporation, and corporate decision makers are held accountable to those who have direct investments in the firm o Three key issues in thinking about governance structures. a) Who is the corporation to be governed for? b) What are the respective rights and duties of corporate directors, officers, shareholders, creditors, and other corporate constituencies? c) What should be the role of the state in regulating corporate governance, and are corporate and securities laws aimed at the same purposes? Berle & Means (1932) Grown to tremendous proportions, there may be said to have evolved a “corporate system” (as there once was a feudal system) which has attracted to itself a combination of attributes and powers, and has attained a degree of prominence entitling it to be dealt with as a major social institution. Mitchell (1995) No institution [the corporation] other than the state so dominates our public discourse and our private lives. In our world, corporations make most everything we consume. This awesome collective power also leads to the problems created by corporations. The very power that corporations have over our lives means that, intentionally or not, they profoundly affect our lives. Corporate Theories Nexus of Contracts Theory Markets and contractual relations should govern. Public regulation should only facilitate, not restrict corporate activity. Shareholders have primacy as residual claimants to corporation’s assets and party least able to contract to protect their inputs to the corporation. Gains and losses are their lot as they are last in line (creditors have fixed claims, employees negotiate terms of employment, etc.) See p. 23 Managers are agents of the corporation. Corporate officers need only act in the SH interests. Shareholders need to control agency costs. Problem: Fails to take into account others who are unable to fully contract their relationship. Does not align with Canadian position that a duty is owed to multiple stakeholders. Fischel (The Corporate Governance Movement 1982) Those who argued that corporations have a social responsibility and, therefore, that managers have the right, and perhaps the duty, to consider the impact of their decisions on the public interest assume that corporations are capable of having social or moral obligations. This is a fundamental error. 70 Tufo, Camion, Niziblian Summer 2010 A corporation … is nothing more than a legal fiction that serves as a nexus for a mass of contracts which various individuals have voluntarily entered into for their mutual benefit. Since it is a legal fiction, a corporation is incapable of having social or moral obligations much in the same way that inanimate objects are incapable of having these obligations. Only people can have moral obligations or social responsibilities, and only people bear the costs of non wealth-maximizing behaviour. Social reformers are focusing on the rules of corporate governance because they have failed to achieve their aims through the political process. Viewed as a contract issue, the question can be analyzed in much more concrete terms. Do investors, as long as corporations lawfully may be formed for profit, have any duty to sacrifice profitable opportunities to benefit some other parties? And do managers, acting as agents for investors, have any right or duty to sacrifice profitable opportunities to benefit some other party? Team Production Theory (Blair and Stout 1999) The primary job of directors is not to act as agents who ruthlessly pursue shareholders’ interests at the expense of employees, creditors, and other team members. Rather, directors are trustees for the corporation itself – mediating hierarchs whose role is to balance team members’ competing interests so as to keep everyone happy enough for the productive coalition to stay together. Power Coalition Theory (Lynne Dallas 1988) The power model depicts the firm as an institution with its own internal structure that seeks to decrease its uncertainty by increasing its own autonomy and discretion over its environment. It utilizes various strategies to decrease its dependence on its environment, thus muting the effects of market constraints. According to the power model, not only are organizations constrained by the political, legal and economic environment, but, in fact, law, legitimacy, political outcomes, and economic climate reflect, in part, actions taken by organizations to modify these environmental components for their interests of survival and growth. Thus the firm is not merely reactive with respect to its environment but proactive. Progressive Approaches to Corporate Law Feminist Legal Theory (Kelly Testy 2004) Corporate decisions should consider a wider range of constituents without the hierarchy of the SH primacy model. Feminist insight into concepts of care and connection can and should give increased substantive context to director and officer duties. Interest Group Theory of Corporate Law What makes legislators adopt one approach of corporate statute over another? Interest groups influence that outcome. Rules are the output of political processes in which politicians maximize political advantage and interest groups compete for rules that transfer wealth to themselves, resulting in the transfer of wealth from less to more powerful coalitions. Political contributions buy corporate managers considerable political influence. Laurence Snider (2004) Key elites in the new world economy have heavy vested interests in getting some interpretations accepted and others rejected (interpreting the laws of the market with neo-liberal tenets; interpreting scientific data; funding scientific research) Criminal law is expensive and does not work when it comes to the crimes of the powerful (marketing unsafe products, maintaining unsafe workplaces, defrauding workers, dumping toxic waste, etc.). The powerful better respond to reasoned persuasion and rewards or tax breaks and market incentives. Agency Costs and Governance o Agency cost theory assumes that directors and officers are the agents of undiversified shareholders, and that governance can be measured by control of agency costs as a means of enhancing economic efficiency 71 o Governance strategies can be viewed as harm prevention devices that reduce agency costs by attributing monitoring duties to claimholders or related parties; for example, granting voting rights to one set of claimholders, or imposing gatekeeping responsibilities on directors and auditors (liability strategies, governance structures, compensation) o Agency costs can also be reduced by way of compensation decisions – i.e. agent misbehaviour may be minimized ex ante through special forms of executive compensation, such as bonus plans, which tie the manager’s salary to firm performance Agency Cost Strategies and Efficient Capital Markets o If capital markets are efficient, then the firm will bear all agency costs and it would voluntarily agree to adopt optimal harm prevention strategies. If capital markets are informed of the agency costs of a particular firm, then that firm will bear them itself in its cost of capital and debt. As a consequence, the firm will wish to take efficient preventive measures to reduce agency costs o However, the firm may lack an adequate incentive to do so if capital markets are inefficient and the probability of manager misbehaviour is not fully known by investors. o Nevertheless, even in an inefficient market the firm’s choice of governance structures is more likely to be reflected in stock prices, making choice of governance important Questions 1. What approach to corporate governance do you believe makes the most sense and why? 2. What elements should be contained in a corporation’s statute to advance your vision of corporate law? Keep in mind the need to minimize agency costs. Directors What is Needed to Become a Director? o Natural persons o Over 18 years of age o Not bankrupt o Not of unsound mind - See CBCA s. 105(1), QCA ss. 123.73, 86(4), 179; QBCA s. 108; CCQ, 327 – See generally, QBCA, CHAPTER VI o Do not have to be shareholders of the corporation - Québec corporations require shareholding in some circumstances (QCA ss. 86 and 179) but will not under the new QBCA (s. 109) o Publicly held corporations must have at least three directors, while closely held corporations may have as few as one: QBCA s. 106 o 25% of directors must be Canadian, but no QC residency requirements: CBCA 105(3) Election of Directors One of the best ways to minimize agency costs o First directors hold office from the date of incorporation to the date of the first meeting of shareholders (within 18 months) o Thereafter, directors are elected by an “ordinary resolution” of the shareholders. (i.e. majority vote) o Shareholders must elect directors at each annual meeting of the corporation, which is held at least every 15 months o The election of directors is one of the most important matters on which the shareholders vote. Since the directors have oversight of the corporation, the election of directors is a significant method by which shareholders can exercise some control over the way in which the corporation is managed. It can even be a useful control mechanism for shareholders whose shareholdings are too small to influence the outcome of the election of directors. This is because their right to vote can be acquired by others who can accumulate sufficient voting rights to influence the outcome of an election of directors and thereby replace directors where the corporation is not being effectively managed. The potential for such a change in control of the voting rights gives management an incentive to act in the interests of shareholders. 72 Tufo, Camion, Niziblian Summer 2010 Term o 3 year term, but directors may be re-elected without limit o If no directors are elected at a meeting where directors should be elected, the incumbents remain in office until successors are chosen. o The corporation’s articles may provide that directors’ terms are staggered. This ensures that there is continuity on the board after any given election, and also serves as a benefit to existing management because it prevents the complete ousting of a board by shareholders in one meeting o However, in a number of corporations, the constituting document now requires annual election of the entire board as a means of providing another accountability check on the activities of directors. Powers of Directors o Authority to manage or to oversee management of the corporation o Directors cannot delegate their powers with respect to certain matters o Can adopt, amend, or repeal bylaws (subject to SH ratification) o Can borrow o Declare dividends o Designate and appoint officers of the corporation, determine their compensation, delegate management powers to them and remove them Outside Directors o CBCA s. 102(2), QBCA s. 106 requires that at least two directors of a publicly traded corporation be outside directors o “Independent” outside directors now comprise the majority of board memberships in Canadian public corporations, and only one-quarter of board members of firms of all asset sizes are employees of the firm o While, arguably, more diverse boards can enhance decision making, there is some debate about just how effective outside directors are in monitoring corporate management o Professors Gilson and Kraakman have recommended reinventing the outside director as a full-time professional director who would have the requisite expertise and would serve on the boards of perhaps six corporations. As full-time directors of a limited number of corporations, they would have a focused mandate and the time to familiarize themselves with the corporations on which they serve as board members. These professional directors would be chosen by institutional investors who might organize a separate clearinghouse to coordinate action among institutional investors for the selection of directors. o Professors Rock and Coffee have questioned the effectiveness of having institutional investors choose and monitor professional directors. Institutional investors also have managers who are separate from the owners of the institutional investor’s funds. The managers of institutional investors may thus not have a sufficient incentive to monitor the professional directors effectively. The institutional investors would also face a conflict of interest because the corporations on the boards of which professional directors would serve would often be clients or potential clients of the institutional investor. XII. CORPORATE GOVERNANCE – SHAREHOLDERS Shareholder Governance o SHs have important financial interests in the corporations in which they hold shares. They occupy a unique position in the corporate governance structure o They have the power to elect and remove the corporation’s directors, and they hold the residual economic interest in the corporation - a “claim” to whatever value might remain in the corporation after the corporation’s fixed claimants have been paid The Power to Manage Automatic Self-Cleaning Filter Syndicate Co. v. Cunninghame (1906) Jurisdiction Facts The company was incorporated in 1896. Its memorandum provided that the company could 73 remove any director before the expiration of his term and appoint another person in his stead, that management and control were vested in the directors, and that they could exercise all powers that the company could exercise itself. Directors were entrusted to purchase for the company and enter into negotiations and contracts in the name or on behalf of the company. A majority of SH passed a resolution presented by the plaintiff to sell the assets of the company. The directors thought this not in the best interest of the company and refused to carry it out. The plaintiff asked for a declaration that the directors were bound to carry into effect a resolution passed at a meeting of SH. At trial, Warrington J held that the majority could not impose that obligation upon the directors, and that on the true construction of the company articles, the directors were the persons authorized to effect the sale. Unless the other powers given by the memo were invoked by a special resolution, it was impossible for a mere majority of SH at a meeting to override the views of the directors. Issues Can a majority of SH override the views of the directors despite the provisions of the incorporation memorandum of the company? Holding No. Appeal dismissed Reasoning o The formal grant of authority to directors removes that authority from shareholders. Directors have absolute power to do all things subject to such regulations as may from time to time be made by extraordinary resolution. o To alter the powers of directors requires not a resolution by a majority of SH at an ordinary meeting, but an extraordinary resolution. o Directors are not agents of the SH, but of the company. It is by consensus of all individuals in the company that they become agents of the company, and it is not fair to say that a majority of SH can alter the mandate of these agents. The minority must be taken into account. The minority can be overborne, but only by a special resolution. o The trial judge notes that directors can only be removed by a special resolution : why would you have such an article if you could eliminate the directors by simple majority- passed resolutions. Comments In practice, senior officers manage rather than directors. Directors have a general oversight role, though this has started to change after Enron. The ratio here is still of importance today. Unanimous Shareholder Agreements o Shareholders can agree to remove authority from the board of directors and give primary managerial responsibility to shareholders: CBCA s. 146 /QBCA s. 213 o The requirement that the shareholder agreement be unanimous effectively restricts its scope to small companies o By taking decision making powers away from directors, SHs acquire all the responsibilities and liabilities of the directors in respect of those decisions o Mechanisms needed to resolve disputes when there is not unanimity among the shareholders CBCA 146. (1) An otherwise lawful written agreement among all the shareholders of a corporation, or among all the shareholders and one or more persons who are not shareholders, that RESTRICTS, in whole or in part, the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation is VALID. Rights of shareholders (5) To the extent that a unanimous shareholder agreement restricts the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation, parties to the unanimous shareholder agreement who are given that power to manage or supervise the management of the business and affairs of the corporation have all the rights, powers, duties and liabilities of a director of the corporation, whether they arise under this Act or otherwise, including any defences available to the directors, and the directors are relieved of their rights, powers, duties and liabilities, including their liabilities under section 119, to the same extent. QBCA 213. All the shareholders of a corporation, whether or not their shares carry voting rights, may agree in writing among themselves or among themselves and one or more third persons to restrict the powers of the board of 74 Tufo, Camion, Niziblian Summer 2010 directors to manage, or supervise the management of, the business and affairs of the corporation, or to withdraw all such powers from the board. A sole shareholder may make a written declaration that restricts the powers of the board of directors or withdraws all powers from the board. The declaration is equivalent to a unanimous shareholder agreement. Shareholder Proposals o Shareholders can bring shareholder proposals to meetings of shareholders: CBCA s. 137; QBCA s. 194 o They must have held the shares for at least 6 months and own either 1% of the outstanding voting shares or $2,000 worth of voting shares o The proposals, even if accepted by the majority of shareholders, are not binding on the directors. o They may, however, be normatively persuasive, given that directors failing to act on a proposal that receives majority support of shareholders may leave themselves vulnerable to not being re-elected by shareholders o Management is obligated to give notice of such a proposal in its proxy soliciting materials and to include a brief statement in support of the proposal if a shareholder supplies such a statement. o However, management can refuse to include a shareholder proposal in its proxy soliciting materials, under one of the grounds in CBCA 137(5) - i.e. if the proposal: Relates to enforcing a personal claim or redressing a personal grievance against the corporation or its directors, officers, or security holders. Does not relate in a significant way to the business or affairs of the corporation Rights are being abused to secure publicity o These days SH proposals can relate to the promotion of political, racial, religious, social, or other causes o Previously, these types of proposals were not permitted o Was the legislature correct in permitting a broader class of SH proposals? Varity Corp. v. Jesuit Fathers of Upper Canada (1987) Jurisdiction Ontario (CA) Facts This was application for an order permitting Varity not to include in its mailing for the annual SH meeting a proposal that the company end its investments in South Africa. Varity was a federal company. CBCA s.131 thus applied and provided that SH may require the company to circulate proposals and supporting statements. The only objection raised was with regard to the content of the proposal, as there was no issue on the status of SH to require circulation, nor on the timing to do so. Issues Can Varity omit to forward a political proposal to its SH? Holding Yes. Reasoning CBCA s. 131(5)(b) provides that a corporation is not required to comply with a SH’s request if the proposal is submitted primarily for the purpose of: o Enforcing a personal claim or redressing a personal grievance o Promoting general economic, political, racial, religious, social or similar causes The language of the proposal and the supporting statement leave no doubt that the primary purpose of the proposal is the abolition of apartheid in South Africa. The fact that there may be a more specific target does not make the primary purpose different. Thus, the company cannot be compelled to distribute the proposal. Shareholder Rights and Powers o To elect directors (don’t have to be at the meeting / can cast vote through proxies). o To amend by-laws (normally a prerogative of directors, but subject to articles, bylaws, and unanimous SH agreement. SH can initiate changes in the bylaws) o To amend the articles (by way of special resolution) o To approve fundamental changes: CBCA s.173(1) requires a 2/3 majority to change the articles. That includes changing the name of the corporation, restricitons on the business, changing the registered office, creating a new class of shares. SH usually get a right to vote on these matters even when their class of shares does not carry a right to vote. 75 Class Voting Rights o Some changes in the corporation require approval from individual classes of shares or, in some instances, a particular series of shares. o These class voting rights generally apply where the proposed change is a change in the rights or restrictions attached to a particular class of shares or series of shares, or where the change can have a significant impact on the particular class of shares. o The reasoning is the same where a change affects a particular series of a same class of shares. See CBCA 176, BCBCA s. 61. Class voting rights can also be exercised in the event of an amalgamation. SH who are entitled to vote separately may be entitled to a right to have the corporation purchase their shares at an appraised value where they dissent a resolution. o CBCA s. 176, QBCA s. 191 Exercise: o When Quick Buys incorporated, Aya had 50,000 common shares, Tomi had 10,000 common shares; Anjala Marshall, Ken Biway, and Maria Toscana each had 25,000 common shares; and Enrico Slate had 25,000 preferred non-voting shares. o Assume for a moment that the board of directors decides that the business should expand further by leasing another 20 stores and raising capital through the sale of another 50,000 common shares and 50,000 preferred non-voting shares to three friends of the original investors. Would the common shareholders have a vote on such a change? Would Enrico Slate have a vote? Why or why not? Shareholders’ Meetings o Annual Meetings (every 15-18 months) Directors choose the date, so they have a strategic advantage. - Elect directors - Appoint auditors - Receive the financial statements of the corporation o Special Meetings - To approve transactions not in the ordinary course of business which require SH approval and to approve fundamental changes o SH can requisite meetings if they hold 5% of voting shares or can make an application to the court to requisition a meeting o Quorum: Minimal representation of SH required to start a meeting - not required that quorum be maintained throughout the meeting to pass resolutions unless otherwise provided. Absence of quorum leads to adjournment. o The principle of notice: Directors must give notice of a meeting from (50-21 days) prior to the meeting. The notice must include the subjects to be discussed. Notice inviting nominations must be given 56 days before the meeting. Where the shares are in the name of a brokerage firm, the firm’s customers do not receive notice of the meetings. However, there are instruments regulating communication to beneficial non-registered owners. Ordinary and Special Resolutions o Used to describe the quantum of majority approval required for different shareholder votes o Ordinary resolution is one for which the requisite approval is a simple majority o Special resolution requires the affirmative vote of two-thirds of the votes cast o Generally, matters dealt with at the annual meeting call for an ordinary resolution, and matters customarily the subject of a special meeting of shareholders require special resolutions Conduct o Run by chair, generally CEO or president of the corporation. o Concerns about the conduct of meetings will arise only where control is disputed o Because control at a shareholders’ meeting in a public corporation will vest in the party that has secured the most proxies, the chair’s conduct has most often been challenged where he or she has rejected proxies. 76 Tufo, Camion, Niziblian Summer 2010 Re Marshall (1981) Jurisdiction Ontario Facts Application under s.252 of the OBCA to tabulate the votes of 405,001 escrowed common shares in accordance with certain written directions of their beneficial owners, and not as voted by their registered owners. The vote related to the election of directors. If the written directions are taken into account in the tabulation of the vote, the directors are removed; otherwise they stay. There were 405,001 common shares held in escrow by the Royal Trust company. Raymond Marhsall had 202,501 and Charles Marhsall had 202,500. The beneficial ownership of the shares was divided among six directors of the company and five other persons. These shares could not be released without the ON or QC Securities Commission, pursuant to an agreement. The shares were recognized to be held in trust for the named persons in the acknowledgement. The applicant and two other beneficial owners gave written directions to R. and C. Marhsall and to the Royal Trust Company to the effect that the escrowed shares were to be voted in favor of the slate of directors nominated by the applicant. This direction was delivered to the chairman at the meeting. C. Marshall voted in favor of the applicant’s candidates, with 202,500 shares. R. Marshall voted for the existing board with 202,501 shares, omitting to execute a proxy in favor of the applicant’s candidate for 36,750 shares. Issues Is the chairman of the meeting required to go beyond the share register and to accept written directions from beneficial owners as to the manner in which their votes shall be cast? Holding No. Reasoning - Requiring the chairman to look beyond the books of the company during a SH meeting is inefficient because he can never be certain that the votes are cast by the ‘true’ beneficial owners of the shares. - To ignore the written directions would violate and disfranchise the vote of the beneficial owners of the escrowed shares. - However, the persons entitled to vote are those registered in the company’s book (as provided by the bylaws and the general rule). - To go beyond the books of the company would require the chairman to “enter into legal questions of beneficial ownership and the question of the propriety of a trustee of a private trust acting separately from his co-trustee”. A chairman does not have the training nor the time to enter into such issues. A chairman at an annual general meeting is not to be placed in the position of determining the legal rights of beneficial owners of shares registered in the name of others. He is entitled to rely on the votes as cast by the registered owner of those shares. Blair v. Consolidated Enfield Corp.  Jurisdiction Ontario (CA) Facts Blair was the president of Enfield. He took legal advice with respect to proxies submitted by Canadian Express, and was told that they could only be voted for the existing/management slate of directors, and could not be voted to replace Blair. could be voted by proxies. Blair also asked if he could make a ruling affecting his own election and was told that he had a duty to do so. He then declared that he and the rest of the management slate of directors had been elected. Canadian Express brought an action for a declaration that their vote was cast in favor of the replacement slate of directors. The court found for Canadian Express. Canadian Express, now in control of Enfield, sought $165,000 against Blair for the recovery of costs, and Blair in turn sought indemnity from Enfield under OBCA 136(1) whereby a director can be indemnified against the costs of an action if the director acted honestly and in good faith with a view to the best interests of the corporation. The indemnity was refused. He then applied to the court for a declaration that he was entitled to indemnification, which was refused as the court found that he did not act in the best interest of the corporation. Blair appealed. Issues Was Blair’s ruling on the overall ballot made with the bona fide intent that the company have a lawfully elected board of director? 77 Holding Yes. Reasoning - OBCA s. 130-136: legal advice does not automatically sanctify conduct, but should be considered - It is preferable to describe the duty of the chairperson as one of honesty and fairness to all individual interests, and directed generally to the best interest of the company - A team of experienced lawyers gave advice to Blair and told him that he had to make a ruling despite his interest in the outcome. Had he received a contrary opinion from Canadian Express lawyers, he would have faced a complex legal problem. There was no obvious error or oversight that would enable Blair to turn away from the advice of the company’s solicitors. - He had to take a decision. - Should proxies have been returned to their representees to obtain new proxies given the sudden nomination of a new candidate? No, it goes too far. - The 15% of the SH who did not come to the meeting also deserved fairness from the chairman - But it goes too far to say that the duty of fairness means that Blair must have selectively assisted those who attended to vote in the process leading up to the vote. His duty of fairness relates to the decision-making process and the conduct of a proper corporate meeting. Note: Corporate management has several advantages in the SH meeting process itself. It can solicit votes in the proxy solicitation process from apathetic shareholders who simply sign and return the proxy form in favor of the management nominee. Management nominees also decide on the acceptance or non-acceptance of proxies and tabulate the votes at SH meetings. Shareholder Voice o The chair of the meeting, acting in good faith and in an impartial manner, must allow shareholders to speak to the matters properly before the meeting, but need not allow more than a reasonable time for reasonable arguments o However, control over the agenda and the power of the chair to recognize speakers can have a significant effect on the outcome of voting Shareholder Meeting Powers o SH can requisition meetings if they hold 5% of voting shares or can make an application to the court to requisition a meeting o But does the right to request a meeting for a stated purpose reverse the division of powers between directors and SH, since the former has powers of management? o If the view is that SH do not have management powers, they can only request meetings for removal and replacement of directors or to propose non-binding resolutions which request directors to consider a specific business decision XIII. CORPORATE SOCIAL RESPONSIBILITY Dodge v. Ford Motor Company (1919) Jurisdiction Michigan Facts Henry Ford, as the controlling director and shareholder of Ford Motor company decided not to distribute any dividends apart from the regular ones (despite huge profits) for a period of time so that he could invest that money in expanding the company’s production plant/capacity. "My ambition," said Mr. Ford, "is to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this we are putting the greatest share of our profits back in the business.“ Issues Must Ford distribute dividends? What purpose should the corporation serve? Holding Yes. The purpose of the corporation is to benefit its shareholders. 78 Tufo, Camion, Niziblian Summer 2010 Reasoning The court does not purport to know Ford’s business better than he does and even accepts that his stated ambitions might be sound in terms of the larger objectives for the business. Nevertheless, a business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the non-distribution of profits among shareholders in order to devote them to other purposes. Interview with Ford in the Detroit News: “And let me say right here, that I do not believe that we should make such an awful profit on our cars. A reasonable profit is right, but not too much. So it has been my policy to force the price of the car down as fast as production would permit, and give the benefits to users and laborers, with surprisingly enormous benefits to ourselves.” o In Court, the following cross-examination took place: - Counsel for Dodge: [D]o you still think that those profits were awful profits? - Ford: Well, I guess I do, yes. - Counsel: And for that reason you were not satisfied to continue to make such awful profits? - Ford: We don’t seem to be able to keep the profits down. - Counsel: . . . Are you trying to keep them down? What is the Ford Motor Company organized for except profits, will you tell me, Mr. Ford? - Organized to do as much good as we can, everywhere, for everybody concerned. . . . And incidentally to make money. - Counsel: Incidentally make money? - Ford: Yes, sir. - Counsel: But your controlling feature . . . is to employ a great army of men at high wages, to reduce the selling price of your car . . . and give everybody a car that wants one. - Ford: If you give all that, the money will fall into your hands; you can’t get out of it. Shlensky v. Wrigley (1968) Jurisdiction Illinois Facts Wrigley is the president and majority SH of the Chicago National League Ball Club which operates the Cubs, a baseball team, and Wrigley Field where the Cubs play home games. The Cubs are not doing so well and a minority shareholder wants to bring a derivative action alleging negligence and mismanagement because Wrigley did not install the necessary infrastructure in Wrigley Field for the Cubs to be able to play night games. Other teams play night games and are more profitable than the Cubs, and the plaintiff asserts that Wrigley is precluding the Cubs from being more profitable by declining to introduce night games. Wrigley, on the other hand, claims that introducing night games would have a bad effect on the neighborhood. Issues Does the plaintiff’s complaint state a cause of action? Holding No. Reasoning o Court is not satisfied that the motives assigned to Wrigley and the other directors are contrary to the best interests of the corporation and the stockholders. o The effect on the surrounding neighborhood might well be considered by a director who was considering the patrons who would or would not attend the games if the park were in a poor neighborhood o Furthermore, the long run interest of the corporation in its property value at Wrigley Field might demand all efforts to keep the neighborhood from deteriorating. o “We do not mean to say that we have decided that the decision of the directors was a correct one. That is beyond our jurisdiction and ability. We are merely saying that the decision is one properly before directors and the motives alleged in the amended 79 complaint showed no fraud, illegality or conflict of interest in their making of that decision.” o “While all the courts do not insist that one or more of the three elements must be present for a stockholder’s derivative action to lie, nevertheless we feel that unless the conduct of the defendants at least borders on one of the elements, the courts should not interfere.” o No evidence that night games would improve the corporation’s position. o Court uses BJR / reverse of Dodge. Defendants arguments, though not great, were considered acceptable. Is CSR a PR Move? (Cheryl Wade 2002) o Is CSR a public relations exercise or does it have substantive content? o Corporate reactions to the September 11: - Contractarian goals of shareholder wealth-maximization were achieved to the extent corporate managers made the right public relations moves. The right corporate response could engender favorable public sentiment for a company, leading to long-term profits derived from loyal consumers to whom the subliminal messages were aimed. Corporate managers used the broadest of communitarian goals—the healing of a nation—to accomplish the contractarian goal of eventual long-term shareholder wealth-maximization CSR in Canada (Anne Golden 2005) CSR is no longer just about corporate philanthropy. It is about sustainability. CSR is about the sound governance of an organization, aiming to promote the long-term health and sustainability of both the company and society at large. Business sense and ethical imperatives are present. The case to be made for good governance and CSR does and should go beyond the appeal to the bottom line. As entities with profound impacts on society, the economy and the environment, companies have an intrinsic obligation to practice good citizenship in these spheres. CSR – A Global View (Anne Golden 2005) o The malfeasance of a corporate division in one country has grave impacts on global operations. This tendency feeds into the wider crisis of trust in public and private organizations that has dangerous implications not just for disgraced organizations but for the social fabric as a whole. It is crucial that companies find ways to manifest their resolve to be good corporate citizens and not exploiters of the public trust. o A second major trend of the present era is the unprecedented power embodied in multinational corporations, which have a mind-boggling capacity to affect the social and economic well-being of hundreds of millions of people. For better or worse, how they choose to operate can have impacts that rival or even exceed the influence of national governments. That gives them an ethical responsibility to pursue profits in a way that does not harm and ideally helps those affected by their operations. o The very survival of our species will depend on the responsible behavior of individuals and organizations toward the environment, and our ability to get beyond short-sighted and self- destructive ways of acting. Business and Human Rights o United Nations Global Compact: 10 principles in the areas of human rights, labor standards, the environment, and anti-corruption. o Business Leaders Initiative on Human Rights: o Businesses increasingly need a stable international environment in which to operate, with sustainable markets and a “level playing field” of opportunities. Human rights offer a common framework for businesses to understand societies’ expectations and deliver value to stakeholders in a more sustainable way. o In a business context, advancing human rights is as much about realizing new opportunities and managing risk as it is about meeting essential global standards. For business, human rights provide a universal benchmark for minimum standards of behaviour o In terms of the “business case” for human rights, although the precise logic can vary between each 80 Tufo, Camion, Niziblian Summer 2010 business sector and country of operation, the following main benefits have been identified: - Improved stakeholder relations - Improved employee recruitment, retention, and motivation - Improved risk assessment and management - Reduced risk of consumer protests - Enhanced corporate reputation and brand image - A more secure license to operate - Strengthened shareholder confidence - More sustainable business relationships with governments, business partners, trade unions, sub- contractors and suppliers Corporate Charity o Courts have consistently upheld the power of corporations to make charitable contributions on the basis of “enlightened self-interest.” The removal of legal obstacles to corporate donations need not result in a rise in corporate altruism. Low rates of corporate giving are a consequence of their accountability in competitive capital and product markets. - A.P. Mfg. Co. v. Barlow: There is no difficulty in sustaining, as incidental to their proper objects and in aid of the public welfare, the power of corporations to contribute corporate funds within reasonable limits in support of academic institutions ... such expenditures may be justified as being for the benefit of the corporation; indeed if need be the matter may be viewed strictly in terms of actual survival of the corporation in a free enterprise system. o Corporate charity is not simply a matter of donations, but also implicates “excessive precaution” costs incurred by a corporation to reduce anticipated harm.In defining charity, there is no reason to distinguish between outright gifts and corporate decisions animated by altruistic motives that reduce firm wealth by failing to extract all possible profits. Corporate Constituency Statutes o More than 25 states in the United States have adopted corporate constituency statutes o These statutes allow directors to take into account interests of non-shareholder constituents. However, the statutes do not mandate consideration of these interests o They also do not give non-shareholder interests a legal right of action against the directors of a corporation for failing to consider their interests Questions: 1) Should there be statutory language in Canadian law that expressly allows directors and officers to consider employee and other stakeholder interests? 2) If so, should there be enforceable remedies for those stakeholders where their interests are not taken into account? Representation of Non-Shareholder Constituents o By way of other stakeholders representation on corporate boards. o i.e. German Aktiengesellschaften - which have a mandatory two-tiered board system consisting of a management board and a supervisory board of non-management directors o Participation on the board of directors may be an effective technique for protecting employees where they make firm-specific human capital investments. An employee representative on the board of directors may also assist in overcoming informational asymmetries between corporate management and employees 81
"Agent Duties LSA AED"