"A Practical Guide for Shareholder Disputes" is an ongoing series, designed for Alberta business owners, directors, and corporate advisors. This series explores key legal concepts and strategic options available when conflicts arise between shareholders in closely held companies.
Read the second article, 'Corporate Governance and How to Proactively Avoid Disputes', here.
Understanding Derivative Action Claims
Disputes over misconduct that causes harm to a corporation can become highly contentious. Determining the appropriate course of action can be complex, particularly in corporations where personal and commercial relationships are closely connected. For this reason, Alberta business owners and corporate advisors should be aware of the derivative action, an important tool available to corporations that have suffered from such misconduct.
What is a Derivative Action?
A corporation is a distinct legal entity which are separate from its shareholders and other individuals who are involved in the company. Therefore, as a general rule, the corporation itself has the legal standing to pursue claims for wrongs committed against it.1 However, a derivative action provides a mechanism for shareholders to initiate a lawsuit on behalf of the corporation in certain circumstances. In order to bring a derivative action, the shareholder(s) must first seek leave (permission) from the Court.
Derivative actions are concerned with protecting the interests of the corporationfrom harm by parties both inside and outside the corporation. A derivative action can be brought when there are reasonable grounds to believe that a corporation has suffered harm from improper acts or omissions by its officers, employees, or directors. For example, if a shareholder suspects an officer is engaging in fraud, the shareholder may take legal action on behalf of the corporation.
There are two avenues through which derivative actions may be initiated. Firstly, the complainant in a derivative action may apply to the Court for permission to bring an action in the name and on behalf of a corporation for any of its subsidiaries.2 Secondly, a complainant in a derivative action may apply to the Court for permission to intervene in an action to which a corporation, or any of its subsidiaries, is a party for the purpose of prosecuting, defending or discontinuing the action.3
Who Can Bring a Derivative Action Claim in Alberta?
For corporations provincially incorporated in Alberta, parties will rely on the Alberta Business Corporations Act ("ABCA") when seeking a remedy for oppressive conduct.4 For corporations which are federally incorporated, parties must rely on the Canada Business Corporations Act ("CBCA").5 The ABCA defines a complainant broadly under section 239. A complainant may include:
- current or former shareholders;
- current or former directors or officers;
- beneficial owners of securities; or
- "any other person who, in the discretion of the Court, is a proper person to make an application."
This definition allows a range of parties, including creditors in some cases, to access the oppression remedy where their interests have been affected. A similar definition is found in the CBCA under section 238.
Subsection 240(2) of the ABCA states that in order for a Court to provide permission to commence a derivative action, the Court must be satisfied that:
- the complainant has given reasonable notice to the directors of the corporation or its subsidiary of the complainant's intention to apply to the Court under subsection (1) if the directors of the corporation or its subsidiary do not bring, diligently prosecute, defend or discontinue the action,
- the complainant is acting in good faith, and
- it appears to be in the interests of the corporation or its subsidiary that the action be brought, prosecuted, defended or discontinued.
Again, a similar provision exists in subsection 239(2) of the CBCA.
When to Bring a Derivative Action Claim in Alberta:
It is important that a claimant begins taking legal steps as soon as they know about the oppressive conduct, even where the conduct is ongoing. Under the ABCA, an oppression claim is subject to a two-year limitation period, after which the claimant is barred from bringing a derivative action claim.6
The Business Judgment rule:
Courts must take care not to interfere in corporate management when they analyze a director's decision and decide whether a derivative action serves the corporation's interests. The business judgment rule requires courts to defer to directors, who are usually best positioned to determine what benefits the corporation. The business judgment rule directs courts to avoid imposing unrealistic standards of perfection on corporations or substituting their own judgment for the directors' chosen course of action.7 Following this rule, courts should refuse a derivative action if it challenges a decision that falls within the range of reasonable options available to the director.8
Derivative Action vs Oppression:
When unfavorable conduct has occurred within a corporation, it is important to consider whether a stakeholder should initiate an oppression claim or pursue a derivative action. Unlike a derivative action, which is aimed at protecting the interests of the corporation, oppression actions are a different type of legal claim which is aimed at protecting the interests of corporate stakeholders whose interests have been unfairly prejudiced or disregarded. Although these two remedies may overlap in certain circumstances, oppression claims are concerned with personal harm suffered by the complainant, while derivative actions seek to address wrongs committed against the corporation. Notably, unlike derivative actions, oppression claims do not require leave (i.e. permission) of the Court to proceed.
The oppression remedy and the derivative action are two different remedies, each with its own underlying purpose and statutory basis.9 The oppression remedy is a personal remedy, whereas a derivative action must be sought on behalf of a corporation. A claim must proceed by way of derivative action in the following circumstances:
- The claim only seeks to recover for wrongs done to a public corporation;
- The relief sought is only for the benefit of the corporation; and
- There is no allegation that the complainant's personal interests have been impacted in a way that is different from other stakeholders' interests.10
Nevertheless, the oppression remedy and the derivative action are not mutually exclusive where the factual circumstances give rise to both types of claims.11 Both the oppression remedy and derivative action may be pursued where the misconduct harmed the corporation and "directly affected the complainant in a manner that [is] different from the indirect effect of the conduct on similarly placed complainants."12An example of where the oppression remedy and the derivative action may overlap is when directors of closely held corporations engage in self-dealing that harms the corporation as well as other shareholders or creditors.13 The misappropriation of funds may affect only the company (and therefore the indirect interests of all shareholders), but the direct interests of the minority shareholder as a creditor of the company.14
Courts would be more persuaded to allow both the derivative action and oppression remedy to be pursued in a closely held company. In closely held corporations with only a few shareholders, the need for court leave is reduced, since the risk of frivolous lawsuits is lower. As a result, courts are generally more willing to allow the oppression remedy, which does not require leave, to be pursued alongside a derivative action.15 Both legal options might be pursued if the conduct in question gave rise to both a wrong against the corporation and a separate, distinct wrong against the complainant. Determining when someone should pursue a derivative action versus oppression action is not always a bright-line distinction.16 In making this determination, a Court must examine the statutory text and the facts of the claim at issue.
Lastly, it is important to note that, unlike an oppression claim, a derivative action is not a standalone remedy but a procedural mechanism used to commence legal proceedings on behalf of the company.17
Conclusion:
Derivative actions are a powerful tool to protect the interests of a corporation. However, given their complexity and the fact-specific nature of these claims, potential complainants and corporations alike should seek experienced legal advice before proceeding.
If you are facing a dispute involving potential harm to a corporation, seeking timely legal advice can help you determine the best path forward. Brownlee's experienced commercial litigation and corporate services teams can assist in navigating these disputes and pursuing legal solutions best suited to your needs.
Footnotes
1. Hercules Managements Ltd. v. Ernst & Young, 1997 CanLII 345 (SCC), [1997] 2 SCR 165 at para 59.
2. Alberta Business Corporations Act, RSA 2000, c B-9, section 1(a).
3. Alberta Business Corporations Act, RSA 2000, c B-9, section (1)(b).
4. Business Corporations Act, RSA 2000, c B-9 [ABCA].
5. Canada Business Corporations Act, RSC 1985, c C-44 [CBCA].
6. Canada Business Corporations Act, RSC 1985, c C-44 [CBCA].
7. 1719349 Alberta Ltd v 1824766 Alberta Ltd, 2023 ABKB 207 at para 49.
8. 1719349 Alberta Ltd v 1824766 Alberta Ltd, 2023 ABKB 207 at para 49.
9. Rea v Wildeboer, 2015 ONCA 373
10. Rea v Wildeboer, 2015 ONCA 373
11. Rea v Wildeboer, 2015 ONCA 373, at para 26.
12. Rea v Wildeboer, 2015 ONCA 373, at para 29.
13. Malata Group (HK) Ltd v Jung, 2008 ONCA 111 at para 31.
14. Rea v Wildeboer, 2015 ONCA 373, at para 31.
15. Malata Group (HK) Ltd v Jung, 2008 ONCA 111 at para 39.
16. Malata Group (HK) Ltd v Jung, 2008 ONCA 111 at para 26.
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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.
