Canada: Mennillo V. Intramodal Inc. — Resigning As Director May Entail Forfeiting Shares

In last Friday's decision regarding shareholder disputes, the majority of the Supreme Court of Canada in Mennillo v. Intramodal Inc., 2016 SCC 51 dismissed the oppression remedy appeal of a former shareholder, denying that the shareholder had a right to reverse a share transfer which did not comply with the Canada Business Corporations Act ("CBCA"). In so doing, the Court distinguished a breach of the formalities of the CBCA by the corporation from a proper claim of oppression by a shareholder and found that a private agreement with another shareholder – separate and apart from the corporation – resulted in the loss of shares upon resignation as director. A strongly-worded dissent by Justice Côté found that the breaches of formalities of the CBCA by the corporation undermined important principles of corporate law.

The Shareholdings

Like many start-up ventures, the parties in this case were friends who decided to go into business together. Mennillo agreed to finance the business and Rosati would contribute the operating expertise. Intramodal Inc. was incorporated in 2004 under the CBCA, both parties being named as directors and officers. Shares were issued: 49% for Mennillo and 51% for Rosati. Both the notices of subscription and the directors' resolutions were signed by Rosati alone. Throughout their business relationship the parties rarely complied with the formal requirements of the CBCA. Even substantial monetary advances from Mennillo to Rosati lacked any written formalities.

In May of 2005, for reasons contradicted by each party, Mennillo resigned his position with the company and asked to be removed as a director and officer. The corporation proceeded to give effect to his resignation as director and officer and to transfer his shares to Rosati. At a later date, Mennillo discovered that the business was running successfully and that his shares had been transferred. He objected and, ultimately, sought relief from the court through the oppression remedy.

Intramodal, for its part, was of the view that Mennillo not only resigned as a director but also as a shareholder by virtue of an agreement between Rosati and Mennillo that Mennillo's shares would continue to be held by him as long as he guaranteed all the debts of Intramodal. Once he removed himself as guarantor, his shareholdings also transferred to Rosati.

The Courts Below

At trial, Justice Poirier of the Québec Superior Court was faced with a highly contested evidentiary record. The dealings between the parties were not well recorded in the corporation's books, nor were many of the formalities of the CBCA followed such as resolutions of the directors, signatures on share certificates, and due diligence by the corporation in meeting its share capital requirements. All of the relevant agreements were made verbally and all of the relevant financial transactions were made in cash.

Justice Poirier found that Mennillo was not a credible witness. He largely accepted the evidence of Intramodal and dismissed the action, finding that the shares issued to Mennillo were conditional upon his guaranteeing the company's debts. Therefore, Mennillo ceased to be a shareholder upon his resignation as director and officer in May of 2005 and was a mere creditor of Rosati and Intramodal.

Mennillo appealed. The majority of the Québec Court of Appeal sided with Intramodal and dismissed the appeal on the basis that the trial judge, whose decision was based on key findings of fact, did not make any palpable and overriding error. The majority found that Mennillo was a shareholder whose resignation, coupled with the understanding between the parties, resulted in the retroactive cancellation of the issuance of the shares to Mennillo. In dissenting reasons, Justice Gagnon focussed on the breach of formalities by Intramodal and concluded that since the requirements of section 76 of the CBCA had not been satisfied, there could not have been a valid transfer of the shares from Mennillo to Rosati.

Reasons of the Supreme Court

The reasons of the majority of the Supreme Court focussed on the reasonable expectations of the parties in determining whether the trial judge's dismissal of the oppression claim should be upheld. The majority reasons, written by Justice Cromwell (Abella, Karakatsanis, Wagner, Gascon and Brown JJ concurring) noted that the test for the oppression remedy (following BCE Inc. v. 1976 Debentureholders, 2008 SCC 69) requires two conditions to be met. First, the claimant must show the expectations that he or she claims have been violated and that they were reasonable. Second, the claimant must show that those reasonable expectations were violated by conduct that was oppressive, unfairly prejudicial to or unfairly disregarding of his interests as a security holder. 

The majority accepted the trial judge's findings of fact and concluded that no palpable or overriding error was made regarding the agreement between Mennillo and Rosati that Mennillo's shares would transfer to Rosati upon his resignation as director and guarantor. Chief Justice McLachlin (with Justice Moldaver) concurred with the majority and agreed that there was no reasonable expectation on the part of Mennillo to remain a shareholder, after he resigned and requested that his relationship with Intramodal cease. There was no evidence to establish that Mennillo had a reasonable expectation that his involvement with Intramodal would continue. For that reason, the claim in oppression must fail and, contrary to the majority, Chief Justice McLachlin and Justice Moldaver considered it unnecessary to go further and determine whether there was an effective transfer of shares.

In finding no violation of a reasonable expectation, Justice Cromwell's reasons distinguished a breach of formalities of the CBCA from a breach of reasonable expectations rising to level of a right to relief from oppression. The latter right requires conduct by the corporation that rises to the level of "oppressive, unfairly prejudicial to or unfairly disregarding of the interests of any security holder". A mere failure to follow statutory formalities is insufficient to grant access to the oppression remedy. In support of this conclusion was the finding of fact made at trial that the transfer of shares occurred between Mennillo and Rosati, without the corporation being a party to the agreement.

However, Justice Cromwell's reasons also corrected the Court of Appeal's notion that Mennillo's shares were retroactively cancelled as a result of his resignation as a director. Justice Cromwell noted that an issuance of shares under the CBCA can only be cancelled if the corporation's articles are amended or the corporation reaches a formal agreement to purchase the shares, requiring the directors to pass a resolution, the shareholder to consent, and the tests of solvency and liquidity to be met. None of these conditions for cancellation existed in the case and, therefore, the Court of Appeal conclusion on that point was corrected.

Dissenting reasons by Justice Côté focussed on the principles of corporate law that underlie the formalities for share transfer and cancellation in the CBCA: (i) the principle of the legal personality of the corporation distinct from the shareholder(s) and (ii) the principle of maintenance of capital of the corporation. The closely-held nature of the corporation in this case increased the importance of these principles, according to Justice Côté, and the failure of the corporation to observe the formalities of the CBCA was itself a form of oppression.

Notes for Shareholders

This decision is an important caution for shareholders who have collateral agreements, whether written or unwritten, regarding their obligations as shareholders. If those collateral agreements are not discharged, or are rescinded or breached, a resulting forfeiture of share ownership may be upheld by the courts even in the face of breached statutory formalities. Further, a blanket oppression claim may not be sufficient to gain compensation for the loss of shares even when the corporate statute and articles are breached by the corporation. However, this decision also reiterates the need for corporations to ensure compliance with statutory formalities and the reasons of the majority of the Supreme Court leave open the right of shareholders to challenge conduct that does not comply with formalities, but falls short of oppression. Activist shareholders and their legal advisers in future cases will be well-advised not to rely solely on the oppression remedy and to advance any available claims in regard to specific statutory formality breaches and lead specific evidence of reasonable expectations under a claim for relief from oppression.

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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