The British Columbia Supreme Court's recent decision in Roussy v. Savage, 2019 BCSC 1669, addresses several interesting corporate law issues arising in the context of an insolvent business.
Two individuals formed Sonic Drill Systems Inc. ("SDSI") in 2003 for the purpose of manufacturing and selling mobile drilling rig platforms. Those two individuals, referred to in this article as "RR" and "TS", were each an officer and director of SDSI and held the company's shares through their respective holding companies. A receiver was appointed over SDSI in late-2013 and the company was subsequently assigned into bankruptcy in 2014. RR caused two actions to be commenced arising from SDSI's downfall, making allegations against TS, members of his family, and companies owned by them.
In the first action, RR and companies owned by him, including 466372 B.C. Ltd. ("466"), the company holding RR's 50% interest in SDSI, alleged that TS breached a fiduciary duty owed to RR and 466 by, among other things, misappropriating funds from SDSI for the benefit of TS and members of his family.
The second action was commenced by one of RR's companies pursuant to s. 38 of the Bankruptcy and Insolvency Act, R.S.C. 1985 c. B-3 against TS. In that action, the plaintiff alleged TS breached his fiduciary duty owed to SDSI by using SDSI facilities, materials and personnel for the construction of railway equipment sold to a company owned by TS (the "Conflict") who then sold the equipment to third parties for a profit. The plaintiff sought disgorgement of the profits earned by TS through the Conflict.
The Court dismissed all of the plaintiffs' claims for misappropriation and fiduciary breach in both actions. Two important takeaways from the Court's decision concern: (1) the circumstances under which a shareholder may sue a director; and (2) when a director will be ordered to disgorge profits arising from a conflict of interest. The Court's reasoning on these issues is summarized below.
1. Claims by a shareholder against a director
In order for RR and 466 to succeed against the defendants, they had to circumvent the well-established principle that a shareholder may not sue for a wrong done to a company unless there is both an "independent relationship" with the director and that the shareholder suffered an "independent loss" separate from any loss suffered by the company (relying on Robak Industries Ltd. v. Gardner, 2007 BCCA 61).
The plaintiffs alleged their "independent relationship" with TS was a fiduciary one, arising under the law of partnership and by virtue of the "special relationship" that existed between RR, 466 and TS.
The Court rejected the notion that any per se fiduciary relationship existed between TS and either of 466 or RR under the law of partnership. While RR and TS used the words "partner" and "partnership" in notes describing their proposed business venture, this was insufficient, without more, to give rise to a partnership at law. Further, the Court determined that, as it was always TS's and RR's intention to pursue their business through a corporation, and that that is exactly what occurred, any partnership between RR or 466 and TS would have been subsumed in the corporate form. There was no fiduciary relationship arising from a partnership in this case.
The "special relationship" between RR, 466 and TS was alleged to consist of TS and RR having had business relations with one another over the past 35 years, RR trusting TS, the bond of friendship between them and 466 being a shareholder of SDSI. The Court determined that friendship, trust and status as a shareholder are not sufficient to satisfy the test for making out an ad hoc fiduciary relationship. Further, RR, based on his involvement in the business and access to the business's financial information, was not vulnerable to TS in the sense required to place upon TS the onerous obligations of a fiduciary. The Court emphasized this was a commercial relationship and fiduciary relationships were "relatively rare" in this context as the "imposition of fiduciary duties runs counter to the logic of self-interest that is presumed to underlie most commercial relationships."
The plaintiffs failed to make out an "independent relationship" in the circumstances and their claims were dismissed.
2. Disgorgement of profits under the Business Corporation Act, SBC 2002, c. 57 (the "Act")
Under Division 3 of Part 5 of the Act, a director is liable to account to the company for any profit that accrues to the director under a contract or transaction in which the director holds a "disclosable interest". Section 147 of the Act identifies a "disclosable interest" for the purposes of Division 3, Part 5. Sections 148 and 149 make a director liable to account to the company for any profit accruing to the director as a result of a contract or transaction in which the director holds a disclosable interest, unless the consent and disclosure requirements of those sections are met. As RR and TS conducted SDSI's corporate governance in an informal manner, the disclosure and consent requirements were not strictly complied with.
Even if a director fails to strictly comply with ss. 148 and 149, a court will only order disgorgement if it determines, pursuant to s. 150 of the Act, that the contract or transaction was unfair or unreasonable to the company. Fairness and reasonableness are to be assessed from both a procedural and substantive perspective.
The Court held that Division 3, Part 5 of the Act was a complete code for the purposes of a director's liability to disgorge profits due to a conflict of interest. On the fairness and reasonableness of the arrangement, consisting of SDSI manufacturing equipment at cost plus 20% for TS's company, the Court decided it was:
- procedurally fair because it:
- had been discussed and informally agreed-to by TS and RR at SDSI's inception; and
- RR was kept generally apprised of the manufacturing work performed by SDSI for TS's company throughout SDSI's existence;
- substantively fair, referring to the volume of documentary evidence and expert opinion which supported TS's position that he abided by the arrangement agreed to between he and RR.
As the transactions between SDSI and TS's company were procedurally and substantively fair and reasonable, TS was not required to disgorge profits earned through the alleged Conflict.
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