Ontario – leave denied to commence derivative action subject in part to arbitration – #421

In Hevey v. Wonderland Commercial, et al., 2021 ONSC 540, Mr. Justice Spencer Nicholson refused leave to commence a derivative action in which part of the dispute was subject to arbitration before an accountant.  Each of the parties to the proposed derivative action indicated they had “made every effort to nominate an accountant to arbitrate pursuant to the Settlement Agreement and that the other side was non-cooperative in the process”.  Nicholson J. determined that the parties’ contract provided a mechanism for dealing with the dispute and, despite “superficial attempts to comply”, the parties could remit the matter to arbitration. Bringing an action in respect of that part of the dispute “does not appear necessary”.

Applicant sought leave under section 246(1) of Ontario’s Business Corporations Act, RSO 1990, c B.16 (“OBCA”) a derivative action on behalf of Wonderland Commercial Centre Inc. (“WCC”).  At para. 36, Nicholson J. signaled the purpose of a derivative action under the OBCA.

Derivative actions under s. 246 of the OBCA are available, with leave of the court, to assert claims to recover damages for wrongs done to a corporation where the directors and/or officers of the corporation do not intend to pursue those claims”.

That section reads in part as follows and sets out the grounds which an applicant must satisfy when seeking leave.

Section 246 (1) Subject to subsection (2), a complainant may apply to the court for leave to bring an action in the name and on behalf of a corporation or any of its subsidiaries, or intervene in an action to which any such body corporate is a party, for the purpose of prosecuting, defending or discontinuing the action on behalf of the body corporate.

(2) No action may be brought and no intervention in an action may be made under subsection (1) unless the complainant has given fourteen days’ notice to the directors of the corporation or its subsidiary of the complainant’s intention to apply to the court under subsection (1) and the court is satisfied that,

(a)  the directors of the corporation or its subsidiary will not bring, diligently prosecute or defend or discontinue the action;

(b)  the complainant is acting in good faith; and

(c)  it appears to be in the interests of the corporation or its subsidiary that the action be brought, prosecuted, defended or discontinued”.

WCC was incorporated April 17, 2000 for the purpose of acquiring and developing a property in Ontario. 1705817 Ontario Inc. (“170 Inc.”) owns all the shares in WCC.  170 Inc. itself initially had four (4) shareholders but at the relevant time period had only a single shareholder, PMP Trust.  See paras 4-7 for more background of the individuals involved as either officers/directors/shareholders and the shareholder corporations.   The respective roles of the individuals are set out at paras 12-15 of the reasons.

Disputes arose but, following the start of litigation in March 2019, the parties entered into a settlement agreement (“Settlement Agreement”).  The Settlement Agreement allowed the parties to complete a particular property transaction but (i) retain monies in trust at different law firms, pending further agreements, to address claims made by the respective parties to those monies and (ii) deposit the balance of the transaction proceeds in trust with WCC’s lawyers.  Payments out of the latter balance could be made to arm’s length disbursements for certain defined purposes, either upon consent or pursuant to a dispute resolution process for disbursements.

In the event of a disagreement over the payment of a disbursement, an accountant was to be appointed by mutual agreement to arbitrate the issue between the parties”.

Applicant sought leave to allow him to institute a derivative action by WCC against two (2) of the individuals and to seek damages for alleged oppressive conduct, breach of fiduciary duties, breach of duty of care and breach of statutory duties.  The proposed defendants disputed those allegations and provided their own context and explanations.  See paras 24-32 for more detail on the parties’ respective allegations.

Nicholson J. observed the status of the parties’ attempts to pay or block payment to creditors and to engage in arbitration with the accountant.

[34] A great deal of the motion material was devoted to describing the professed efforts by each side to agree to pay various creditors and the roadblocks that each say the other was putting up to thwart those payments.  Eventually, most of the creditors appear to have been paid, chief among them the CRA.  There were some penalties incurred with respect to the outstanding amounts owing to CRA due to delays between the parties in agreeing to make these payments.  The accountant has also refused to undertake the accounting work with respect to 2019 due to its unpaid accounts.

[35] Likewise, each side indicates that they made every effort to nominate an accountant to arbitrate pursuant to the Settlement agreement and that the other side was non-cooperative in the process”.

(1) Principles for derivative action – Nicholson J. set out the applicable principles and burdens of proof associated with an application under the OBCA for leave to institute a derivative action.  He determined that Applicant did qualify as a “complainant” under section 245 of the OBCA and that WCC’s president refused to authorize the litigation proposed by Applicant.

(2) Good faith – Based on his review of the record set out at paras 48-58, Nicholson J. determined that Applicant failed to demonstrate his good faith in seeking leave. “It is my view that the application has been commenced in order to gain a tactical advantage in the matrimonial proceedings and the dispute over the alleged loans”.

(3) Whether derivative action is in WCC’s interests – In addition, based on his further review of the record at paras 59-75 in regard to an “overlapping issue”, Nicholson J. also determined that the derivative action was not in WCC’s interests.

[59] An overlapping issue with whether the applicant is acting in good faith is whether it is in the interests of the company for leave to be granted.  As noted, this is a low bar to surpass.  At this stage of the analysis, the court is not called upon to determine questions of credibility or to resolve the issues in dispute, and ought not to try.  Some courts have adopted the test “where the intended action does not appear frivolous or vexatious and could reasonably succeed” or an “arguable case” (see L&B Electric Ltd. v. Oickle, 2006 NSCA 41).

[60] In my view, however, the Court cannot ignore the evidence presented to it and simply rubber stamp that the proposed claim is “arguable”.  There must be some judicial scrutiny”.

The proposed derivative action contained three (3) broad categories of claims, identified at para. 61.

In analysing this “overlapping issue”, Nicholson J. expressed “skepticism” regarding certain allegations made by Applicant regarding (i) his late awareness of proposed defendants’ alleged misappropriation of funds but for which Applicant could have claimed but had not and (ii) his lack of awareness of certain payments made by proposed defendants and for which damages were sought.  In the midst of those remarks, Nicholson J. specifically pointed to the availability of the arbitration before the accountant and the parties’ disputed efforts to engage in that process.  When commenting on whether the derivative action was in WCC’s interests, in regard to those claims involving alleged failure to agree to pay entities from the monies held in trust, Nicholson J. relied on that arbitration before the accountant to conclude that a derivative action “does not appear necessary”.

[63] As I note, there was a Settlement Agreement that provides a mechanism for dealing with non-payment to arm’s length parties.  Frankly, both sides seemed to make superficial attempts to comply with the agreement and authorize payments, but at the same time, thwart compliance with the agreement.  There is a remedy that both sides can implement to remit the matter to arbitration”.

[64] While the non-payment to the CRA did lead to a substantial penalty being imposed by the CRA—approximately $85,000, from the totality of the evidence it is not my impression that any of the parties have been particularly concerned about obligations owing to CRA since the inception of these companies.

[65] In any event, there are emails from Jeremy’s solicitor dated prior to the commencement of this Application authorizing the payment of arm’s length invoices.  The CRA has now been paid.  [R]’s solicitor proposed three arbitrators as of June 27, 2019, prior to the within Application.  Bringing an action in respect of the alleged non-payments in light of the Settlement Agreement does not appear necessary”.

Nicholson J. dismissed the application for leave to commence the proposed derivative action.

urbitral notes – First, for a derivative action sought to dispute arrangements undertaken to pursue arbitration by the corporation, see Meliambro v. Eco Oro Minerals Corp., 2017 BCSC 988.

[1] Eco Oro Minerals Corp. (“Eco Oro”) is a precious metals exploration and development company with operations in the Republic of Colombia. Its principal asset was a late exploration stage gold and silver project located there. The project has been frustrated by actions taken by the Colombian government in 2016, which has resulted in Eco Oro bringing an international arbitration claim in which the company seeks to recover over US$250 million against Colombia. The company, through its executive chair, [AS], sought financing for pursuing the arbitration claim, and entered into an investment agreement with Trexs Investments, LLC (“Trexs”) for that purpose. As part of the investment agreement, Trexs received contingent value rights (“CVRs”) which would entitle Trexs to 51% of the gross arbitration proceeds if the arbitration is successful. The respondents [AS], Amber Capital LP (“Amber”) and Paulson & Co. Inc. (“Paulson”) — all shareholders of Eco Oro — also entered into investment agreements with the company with provision for CVRs commensurate with their investments.

[2] The petitioners [RM] and [DP] are shareholders of Eco Oro. Their petition seeks a declaration that the affairs of Eco Oro were conducted in an oppressive manner and leave to bring a derivative action. It was filed on December 20, 2016 and is set for hearing in July 2017”.

Second, for an unsuccessful appeal of leave granted to institute a derivative action seeking recovery of $2 million in arbitration expenses, see Discovery Enterprises Inc. v. Ebco Industries Ltd., 1998 CanLII 7049 (BC CA).

[6] Thus, as Ebco concedes, the real issue on this appeal is whether the Chief Justice erred in his finding that “the evidence is sufficient to show that this action is being brought for the purpose of re-claiming the arbitration expenses which Discovery feels were improperly paid out”, a finding which disposes of the issue of good faith.  This finding was based on the whole of the evidence, following seven days of argument and a full review of the record, including hundreds of documents and volumes of cross-examination on affidavits.  There is, in my view, no way in which to give effect to Ebco’s various theories of bad faith without substantially rejecting the affidavit evidence, extensively cross-examined on by counsel for the respondent, on which Discovery relied in the court below”.

Third, for an unsuccessful application for leave to institute a derivative action involving, in part, an alleged interest in a significant claim subject to arbitration versus control of the corporation, see DeCotiis v. Petromin Resources Ltd., 2017 BCSC 514.

[48] The test as discussed in [Discovery Enterprises Inc. v. Ebco Industries Ltd., 1998 CanLII 7049 (BC CA)] and [Jordan Enterprises Ltd. v. Barker, 2015 BCSC 559] centres around the primary purpose for bringing the action and the extent to which there are ulterior motives.  In this case, I note that [C] and [D] moved to take over the direction of the company almost from the start of their involvement.  Their proposal of August 2015 had nothing to do with the arbitration, and indeed downplayed that as a meaningful factor.

[49] When that attempt failed, their next step was their proxy drive of December 2015, by which time the prospect of a derivative action was apparently already in contemplation.  Now the aim was framed as preserving the benefit of a potential settlement or award in the arbitration.

[50] As the petitioners proceeded along this path, they engaged in highly questionable tactics as noted in para 73 of the judgment of G. C. Wetherill J. quoted above.  These led the judge to conclude that their intention was “to cause havoc to the management of Petromin and its ability to focus on Petromin’s business”.

[51] [S] submits that the questionable tactics decried by G. C. Wetherill J. are irrelevant because the real question is whether the petitioners are truly proposing to bring the action for its ostensible purpose.  I disagree.  While such behaviour may not eliminate the possibility of good faith, it remains relevant to the petitioners’ purpose and forms part of “all of the evidence and the particular circumstances of the case” on the basis of which the existence of good faith is to be determined, as noted in Discovery Enterprises.

[52] What, then, is their purpose?  Is this proposed action simply another way to achieve their long-held goal of taking over the company?  [S] submits that it is important not to confuse the petitioners’ means (takeover attempt/derivative action) with their end (benefiting all of the shareholders of Petromin by maximizing the potential return from the arbitration award).  But the evidence, I find, does not support this analysis.  That their focus is now on the potential riches of a successful outcome in the arbitration does not impress good faith on what I find to be their underlying aim, which is to gain control of the company through ousting the directors by any means possible.  As I discuss in the next section, it is not at all clear that the end of maximizing shareholder value will best be achieved through the perhaps remote possibility of a billion-dollar award; but in any event, given the petitioners’ predatory actions since investing in Petromin, more cogent evidence than they have adduced would be required to establish good faith at this stage”.