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Exercise of Legal Powers By Director Constitutes Oppression of Minority Shareholders

Posted by Ron Davis on Wed, Sep 24, 2014 decision by the Ontario Superior Court of Justice in Paul v. 1433295 Ontario Ltd. (2013 OSCJ 7002), illustrates that the oppression remedy is available to complainants, even when the actions that are the subject of the complaint are the result of a lawful procedure available under Ontario corporate legislation. The Court held that, although the procedure was lawful, the intent of the action was to squeeze out the affected shareholders and the results were oppressive to the minority shareholders’ interests.

In 1998, Mr. Bahia engaged Russell Paul, a real estate broker specializing in hotel properties, to assist him in acquiring a hotel property in Canada. Bahia eventually decided to purchase the 100 year-old Prince Arthur Hotel in Thunder Bay, Ontario for $3 million in 2001. Paul offered to become an investor by foregoing his $100,000 commission on the purchase as his contribution towards the purchase price. Bahia agreed and Paul and his spouse, Doreen Downs Paul, each received 10 percent of the shares of 1433295 Ontario Ltd. (“the Corporation”), which was incorporated to own the property and operate the hotel. Bahia contributed $1.3 million to the purchase price with the balance from the Business Development Bank of Canada. The Corporation’s initial directors were Bahia and Mrs. Downs Paul.

Although the Pauls only contributed 3.3% of the purchase price, the Pauls received a 20% interest, with Bahia holding the remaining 80% interest in the Corporation. The Court noted that this distribution of interests was made “because Mrs. Downs Paul was going to be involved in the management of the Hotel, allowing Mr. Bahia to focus on his other business ventures in the United Kingdom where he lived and elsewhere. Even though Mrs. Downs Paul’s experience in managing the day to day operations of a hotel was little to non-existent and there was no agreement between the parties as to what her exact duties would be and whether she would be paid for those duties, that was the arrangement the parties put in place.” (para. 7)

Shortly after the hotel was purchased, Mrs. Downs Paul was dismissed as manager and both Pauls were banned from the hotel by Bahia. She was removed as a director of the corporation in June 2001 at a shareholders’ meeting. In 2006, Bahia needed funds to renovate and repair the hotel and he requested that the Pauls contribute more funds to these efforts. They refused to do so. The corporation adopted a notice of special resolution for the shareholders’ meeting in February 2007, noting the need for $700,000 to be invested, the refusal of Bahia to invest any more unless the Pauls invested funds proportionate to their shareholdings, and proposing the corporation reduce the number of issued shares on a 40-1 basis. The result of such a reduction would be that Bahia’s 80 shares would be reduced to 2 while each of the Pauls’ 10 shares would be reduced to ¼ of a share. The resolution went on to provide that scrip certificates would be issued for the fractional shares.

The Ontario Business Corporations Act provides for scrip certificates in s. 57. The court described the effect of the relevant provisions as follows: “Under section 57(1) of the OBCA, a corporation may issue a certificate for a fractional share or scrip certificate that entitle the holder to receive a certificate for a full share by exchanging scrip certificates aggregating a full share. Subsection 57(2) permits the directors of the corporation to attach conditions to the scrip certificates, including a condition that the certificates become void if not exchanged for a full share before a specified date. A holder of a scrip certificate is not entitled to exercise voting rights or to receive dividend.” (para. 117) However, the shareholder meeting did not proceed and the parties attempted to negotiate a fair price for the Pauls’ shares without success.

In March 2008, a notice of a shareholder meeting later that month, at which the share reduction resolution was to be re-introduced, was sent to the Pauls. At the shareholder meeting the Pauls disagreed with the motion and exercised their dissent and appraisal rights under the OBCA, requiring the corporation pay them fair market value for their 10 shares each. The Pauls sought a remedy under the oppression remedy provisions of the OBCA claiming that by reducing their shares to ¼ each and providing scrip certificates that could only be exchanged for shares when the certificates had an aggregate value of 1 share, Bahia was extinguishing their interests without compensation.

The court rejected the Bahia’s defense that the process followed was authorized and permitted by the OBCA, noting: “Mr. Bahia employed a lawful procedure available under the OBCA. At the same time, the manner in which he exercised it rendered the shares of the Pauls worthless. They could not exchange the fractional share scrip certificates for a full share. While a lawful process was followed, it is not clear how such proposed resolution was in the best interests of the corporation or that Mr. Bahia acted appropriately when he offered to purchase the Pauls’ shares at a price he acknowledged he would not have accepted for his shares. The BDO “valuation” which was attached to the offer was replete with disclaimers that made the opinion of value meaningless. I find that the real purpose of the resolution was to squeeze out the Pauls, the minority shareholders, an action that was considered by the Supreme Court of Canada in B.C.E. Inc. to be oppressive conduct.” (paras. 124-25).

This case emphasizes, once again, that the courts are vigilant in protecting minority shareholder rights, and will not accept that the directors’ actions are authorized or permitted by law as a complete defense. Rather the courts will investigate the directors’ motives and the effect on the minority’s interests to determine if either is unfairly prejudicial or disregarding of those interests.

STP has recently published an update to its publication Directors' Liability in Canada and also publishes the following related guide:

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About the Author

Ronald Davis is an associate professor of law at the Faculty of Law, University of British Columbia. He obtained his Bachelor of Laws degree from the Faculty of Law, University of Toronto in 1990, graduating as that year’s silver medalist. He was called to the Ontario Bar and practiced law in Toronto for 10 years before returning to graduate studies at the University of Toronto. He was awarded a Social Sciences and Humanities Doctoral Fellowship in support of his graduate research and he obtained his Doctor of Juridical Science degree in 2004 at the University of Toronto. While pursuing graduate work at the University of Toronto, he co-authored Director and Officer Liability in Corporate Insolvency, which was published in 2002.

Ronald joined the Faculty of Law at UBC in 2003 and teaches corporate law, law and economics, trust law and pension law. He has published articles on pension law, corporate governance and insolvency law and has presented a number of papers on these topics both nationally and internationally.

photo credit: neilalderney123 via photopin cc

Tags: Corporate Governance, Business & Legal, Internal Control, Canadian