Canada: Defending Actions Against Shareholders Of Dissolved Corporations

Last Updated: August 29 2007

Article by Michelle Spence, © 2007, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Energy - Oil & Gas, July 2007

On January 30, 2007, the Alberta Court of Appeal released its decision in Enron Canada Corp. v. Husky Oil Operations Ltd. The Court held that a shareholder has a right to defend an action under section 227(4) of the Alberta Business Corporations Act (the Act) by defending the merits of the underlying actions against the dissolved corporation.

Section 227(4) allows a party with a valid claim against a dissolved corporation to pursue shareholders who received corporate property on dissolution, to the extent of that property. Without this provision, a corporation could simply dissolve and largely avoid its obligations to third parties. Although the Act also allows third parties having valid claims to proceed against the dissolved corporation, the dissolved corporation is merely an empty shell having distributed its assets, if any, to its shareholders. Such a corporation has little incentive to defend and if a defence is made, a successful plaintiff will receive little satisfaction. Section 227(4) ensures that corporations wishing to dissolve, along with its shareholders, remain responsible for their obligations to third parties. This case comment discusses the defences available to shareholders sued under s. 227(4).

Facts

In 1995, Marathon Canada Limited (Marathon) and Enron Canada Corp. (Enron) entered into a gas supply agreement in which Marathon agreed to provide Enron with natural gas at a fixed price for 20 years. Seven years later, Marathon terminated the agreement and brought an action against Enron for payments totalling $500,000 allegedly owed under the agreement. Enron responded by counterclaiming for $93,000,000 for wrongful termination of the agreement.

In 2003, Marathon Oil Company (Marathon Oil), the parent of Marathon, sold all the shares in Marathon to Husky MCL Holdings Ltd. (Husky MCL) on the condition that Marathon Oil assume conduct of the litigation and indemnify Husky MCL should Marathon be found liable in the action. Husky MCL later transferred the shares in Marathon to Husky Oil Operations Limited (Husky). On January 19, 2004, Marathon dissolved and distributed its assets to Husky who was the sole shareholder of Marathon at the time.

The litigation between Enron and Marathon continued for two years pursuant to s. 227(2) of the Act which allows an action to proceed against a dissolved corporation as if the corporation had not been dissolved. On December 14, 2005, Enron added Husky to its counterclaim against Marathon pursuant to s. 227(4) of the Act. That section reads:

Notwithstanding the dissolution of a body corporate under this Act, a shareholder to whom any of its property has been distributed in the liquidation is liable to any person claiming under subsection (2) to the extent of the amount received by that shareholder on the distribution, and an action to enforce that liability may be brought within 2 years after the date of the dissolution of the body corporate.

Husky responded by filing a statement of defence adopting the allegations and defences found in Marathon’s pleadings. Enron applied to strike Husky’s statement of defence on the following basis:

  • Husky was prohibited by the statute from asserting any defence that was not related to either (i) its status as a shareholder at the time of dissolution, or (ii) its receipt of property on dissolution; and
  • Even if Husky could defend in this fashion, it was an abuse of process to allow it to so late in the proceeding.

The case management judge ruled in favour of Husky, thus allowing Husky to raise defences relating to Enron’s claim against Marathon. Enron appealed.

Issues

Can a shareholder sued under s. 227(4) of the Act defend the validity of the dissolved corporation’s obligation to the plaintiff on the merits, or will such a defence always amount to an abuse of process?

Position Of The Parties

Enron submitted that s. 227(4) is merely an enforcement provision to be used once the dissolved corporation has been found liable. As such, Husky could only defend on the basis of its status as a shareholder or on the basis of its receipt of property and the extent of any property received. Alternatively, Enron argued that if Husky is allowed to defend on the merits of the claim against Marathon in circumstances where Husky is completely indemnified for any damages found owing and the action has already been fully defended, it is an abuse of process to allow Husky to raise such defences at such a late date.

Husky argued that it is a fundamental principle of justice that a defendant is entitled to raise all defences available to properly defend a claim, and that any limitations on that right must be properly expressed in the legislation. In addition, Husky submitted that because a shareholder’s liability is contingent upon the dissolved corporation’s liability, the shareholder can only make full defence if it is allowed to contest the dissolved corporation’s liability. Further, the party with the interest in defending is really the shareholder. If the dissolved corporation neglects to defend, as it really has no interest in defending the action, the shareholder would, based on Enron’s argument, have very limited defences available to it and could be liable for claims against the dissolved corporation which actually have no merit.

With respect to the abuse of process argument, Husky acknowledged that there may be cases where this argument could limit a shareholder’s right to defend; however, the principles of res judicata, merger and issues of estoppel did not exist in this case because Marathon’s liability had not yet been adjudicated.

The Decision

The Court of Appeal held that a shareholder sued pursuant to s. 227(4) of the Act is entitled to raise defences relating to the dissolved corporation’s liability. The reasons for this finding were threefold.

First, the nature of the shareholder’s liability under s. 227(4) is contingent upon the liability of the dissolved corporation. If the dissolved corporation is not liable, the shareholder cannot be liable. As such, the shareholder should be entitled to raise all meritorious defences to the action unless that right is explicitly circumscribed by statute, and there is no such limiting language in the Act.

Second, it flows from the wording of s. 227(4) that the Legislature has signalled an intention to allow the shareholder to defend the merits of the underlying claim. The limitation period set out at the end of s. 227(4) which specifies that the action against the shareholder must be commenced within two years of the dissolution also draws support for the conclusion that the shareholder is entitled to raise defences relating to the dissolved corporation. It would be nearly impossible to commence the action and recover judgement against a shareholder within the two year period if the action could not be commenced until judgement was obtained against the dissolved corporation. It follows that the lawsuit against the shareholder has to proceed even though the issue of the dissolved corporation’s liability has not yet been determined and, in these circumstances, it should be open to a shareholder to raise valid defences to the dissolved corporation’s liability.

Third, although s. 227(4) contemplates two actions, one against the dissolved corporation and one against the shareholder, it is the shareholder who is the real party at risk when a plaintiff elects to proceed with an action against a dissolved corporation because the dissolved corporation is gone and its assets have been distributed.

Even though Husky was not actually the party at risk because Marathon Oil agreed to fully indemnify Husky, the Court believed that Husky should have the right to defend on the merits of the claim against Marathon. The Court also disagreed with Enron’s argument that if Enron had been able to obtain judgement against Marathon before suing Husky, Husky would have been prohibited from raising such defences because of the doctrines of res judicata and merger. The Court noted that the action against the shareholder is a separate action against a different party and it is unclear as to whether the doctrine would apply.

Finally, the Court held that it was not, in the circumstances, an abuse of process to allow Husky to raise defences relevant to Enron’s claim against Marathon. The case management judge had determined that the only real prejudice to Enron was the possible delay caused by the need for further discoveries and the Court of Appeal was not prepared to interfere with the case management judge’s discretion. The Court of Appeal noted that Enron could have avoided some of the problems it complained of by suing Husky at the point Marathon was dissolved so that the possibility of re-litigating issues was prevented.

Conclusion

A shareholder should be entitled to defend an action brought against it under s. 227(4) of the Act by defending the merits of the underlying claim against the dissolved corporation, primarily because its liability is contingent upon the liability of the dissolved corporation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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