Canada: Business Realities v. Narrow Legalities: The Supreme Court Considers The Oppression Remedy In Mennillo v. Intramodal Inc., 2016 SCC 51

In Mennillo v. Intramodal Inc. 2016 SCC 51, the most recent consideration of the oppression remedy by the Supreme Court of Canada (released on November 18, 2016), the majority confirmed the oppression remedy's equitable purpose, and held that a corporation's failure to comply with the CBCA1 does not, on its own, constitute oppression.

This decision, with particular applicability to small, closely held corporations, reiterated oppression remedy principles set out in the 2008 Supreme Court decision of BCE Inc. v. 1976 Debentureholders,2 that the remedy is concerned with fairness and business realities, rather than narrow legalities.3

Background

In 2004, two friends, Mr. Mennillo and Mr. Rosati, formed an agreement to create a transportation company called "Intramodal". Mennillo agreed to contribute money to start the business, and Rosati brought skills to ensure its success. From the start, the dealings of the parties were "marked by extreme informality"4, where the corporation rarely complied with the CBCA and the parties "almost never put anything in writing". For example, on incorporation in July 2004, Rosati and Mennillo were issued 51 and 49 class "A" shares respectively, though the notices of subscription and the resolution were signed solely by Rosati, neither party paid for his shares (contrary to s. 25(3) of the CBCA), and Mennillo's share certificate was not signed (contrary to s. 49(4)(a) of the CBCA).5

In May 2005, Mennillo sent a letter to Intramodal indicating his resignation as an officer and director of the company. Following this, Intramodal's lawyer filed an amending declaration with the Registraire des entreprises (REQ) to indicate that Mennillo had been removed as a director and shareholder of the company.

In the early stages of the company's development, Mennillo advanced $440,000 to Rosati (not Intramodal) for the purposes of financing the business. In July 2007, Mennillo expressed discontent that he had not received any return on his investment, despite the company's success, and asked that his loan be repaid. Rosati agreed to repay Mennillo the loan plus an additional $150,000, totalling $690,000. It was only after receiving his final payment that Mennillo realized that he was no longer a shareholder of the corporation. At that time, in December 2009, Mennillo applied for an oppression remedy against Intramodal on the basis that Intramodal and Rosati had unduly and wrongfully stripped him of his status as a shareholder of the corporation.

The question before the Court

In a trial that hung on the credibility of the witnesses due to the significant lack of documentation, the trial judge found that Mennillo refused to participate in the venture, and when Mennillo asked to be removed as a shareholder and director of Intramodal in May 2005, he became a lender to Rosati, as a friend, only. Given this key finding, the trial judge found that Mennillo's oppression claim must fail. The trial judgment was upheld by the Court of Appeal for Québec.

Writing for the majority, Justice Cromwell (Abella, Karakatsanis, Wagner, Gascon and Brown JJ. concurring) set out the main question to be decided as whether the trial judge made a reviewable error in finding that in May 2005, Mennillo no longer wished to remain a shareholder because he did not want to be the guarantor of all of Intramodal's debts and transferred his shares to Rosati.

In accepting the trial judge's findings of fact, the majority found Menillo's oppression claim to be groundless. Despite the fact that the corporation failed to comply with legal formalities, the majority found that Mennillo could not have had a reasonable expectation of being treated as a shareholder.6 In concurring reasons, Chief Justice McLachin (Moldaver J. concurring), noted that the appeal could be disposed of on the basis that Mennillo failed to show a reasonable expectation that he would not be removed as a shareholder from Intramodal's books.7

The majority reiterated the constituent elements that are required for any oppression claim to succeed:

  1. The claimant must "identify the expectations that he or she claims have been violated ... and establish that the expectations were reasonably held."8
  2. The claimant must show that "those reasonable expectations were violated by conduct falling within the statutory terms, that is, conduct that was oppressive, unfairly prejudicial to or unfairly disregarding of the interests of any security holder."9

While the corporation failed to comply with the requirements of the CBCA, the failure to comply with the statute, on its own, did not constitute oppression. The majority further held that "the oppression remedy is a discretionary one that is equitable in nature." In order to trigger the remedy, conduct must frustrate reasonable expectations, not merely run afoul of the CBCA.10

Corporate Law issues

While not central to the appeal, the majority also discussed some corporate law issues that will be of interest to corporations operating in Canada, particularly those in Québec.

Can a share transfer be retroactively cancelled?

The CBCA sets out the two ways in which an issuance of shares can be cancelled: (1) if the corporation's articles are amended or (2) if the corporation reaches an agreement to purchase the shares, which requires a directors' resolution, the shareholder's express consent and that the tests of solvency and liquidity be met. The majority stated that it is not possible to retroactively cancel an issuance of shares by way of simple oral consent. 11

What were the consequences of failing to observe the formalities prescribed by the CBCA?

Intramodal's failure to comply with the s. 76(1)(a) of the CBCA that a registered security be endorsed when presented for transfer did not in and of itself invalidate any transfer between the shareholders, as Mennillo ceased to be a shareholder in Intramodal as a result of his transfer of shares to Rosati rather than as a result of an improper registration.

The majority took the view that the failure to comply with the endorsement requirement under s. 76(1)(a) of the CBCA resulted in the failure of the share transfer (pursuant to ss. 60(1) and 65(3) of the CBCA) and a nullity of the transfer, pursuant to articles 1414 and 1416 of the C.C.Q.. The majority observed that this could have resulted in an attack on the transfer on the basis of non-compliance with this formality, had Mennillo sought judicial intervention within three years of becoming aware of the cause of nullity, as prescribed by articles 2925 and 2927 of the C.C.Q..12

Could the shares have been issued conditionally?

The dissenting judge at the Court of Appeal understood the trial judge's reasons as holding that the issuance of the shares to Mennillo had been conditional on his remaining as a guarantor to the corporation. The dissenting judge stated that such conditional status is not set out in the CBCA, and even if it were, such status would have to be specified in the corporation's books. While disagreeing with the dissenting judge's reading of the trial decision, Justice Cromwell substantially agreed with the dissenting appellate judge's position regarding conditional share issuances, and explained that conditions attaching to shares need to be specified in the articles of the corporation and in the securities register.

Dissenting reasons

In her dissent, Justice Côté harkened back to the deep roots of corporate law in Canada to and based her lengthy reasons on: (1) the distinct nature of the corporate personality, and (2) the rule of preservation of capital. Using these principles, Justice Côté explained that corporations are required to operate in accordance with the applicable statutes (in this case, the C.C.Q. and the CBCA) in a manner that does not weaken the strict formal requirements of corporate law, nor confuse the business corporation with the partnership. In Justice Côté's view, had the parties intended their business relationship to be governed by informal dealings, they should have formed a partnership at the outset of their relationship. Once incorporated, Intramodal was required to strictly comply with the formal requirements of the C.C.Q. and CBCA, rather than confuse its interests with its majority shareholder and take a "distrubingly lax" approach to its legal duties.

Function over form? Don't forget good form

This decision will be of particular interest to closely held corporations and fast-growth companies that emphasis function over formality. While this decision may appear to be a win for business function over legal formality, the majority's clear warning that a corporation needs to adhere to statutory requirements, coupled with Justice Côté's strong dissent, serves as reminder to businesses to ensure legislative compliance. By the same token, this decision offers an important reminder for large corporations and activist shareholders: failure to adhere to statutory obligations may give rise to statutory claims in addition to, or in lieu of, an oppression claim.

Case Information:

Citation: Mennillo v. Intramodal Inc., 2016 SCC 51

Docket: 36124

Date: November 18, 2016

Footnotes

[1] Canada Business Corporations Act (R.S.C. 1985, c. C-44).

[2] 2008 SCC 69 [BCE].

[3] BCE at para. 58.

[4] Para. 10.

[5] Paras. 21 – 22.

[6] Paras. 55 – 58.

[7] Para. 86.

[8] BCE, at para. 70.

[9] BCE, at para. 68; s. 241(2) CBCA.

[10] Para. 11.

[11] Para. 63.

[12] Paras. 71 – 74.

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