Resisting A Derivative Action? Provide Sufficient Evidence Of Decision Not To Prosecute

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The British Columbia Court of Appeal underscores the importance of providing sufficient evidence underlying a company's decision not to prosecute or defend a derivative action.
Canada Corporate/Commercial Law
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The British Columbia Court of Appeal underscores the importance of providing sufficient evidence underlying a company's decision not to prosecute or defend a derivative action.

In Eastern Platinum Limited v. Ren, 2024 BCCA 109, Eastern Platinum Limited (EPL) appealed an order granting a shareholder of EPL leave to commence a derivative action against EPL's former CEO. The Court dismissed the appeal. In doing so, the Court emphasized that if directors want the Court to defer to their decision not to prosecute or defend an action, they must provide sufficient evidence of their decision-making processes, including how they considered evidence of the alleged wrongdoing.

B.C. Supreme Court decision

EPL, a publicly traded company in B.C., owns a platinum and chrome mine in South Africa through a subsidiary. The petitioner, Ms. Ren, a shareholder of EPL, alleged that the present and former directors of EPL acted negligently and in breach of their fiduciary duties when they caused EPL to enter into agreements with Union Goal Offshore Limited (Union Goal) for the exploitation of mine tailings at EPL's mine. Ms. Ren sought leave to commence a derivative action under s. 232 of the B.C. Business Corporations Act in EPL's name against its directors for negligence and breach of fiduciary duty.

A derivative action is a claim that is typically brought by a shareholder or director of a company on behalf of the company. An applicant must satisfy four conditions before a Court will grant it leave to commence a derivative action:

  • The applicant has made reasonable efforts to cause the company's directors to prosecute or defend the legal proceeding;
  • Notice of the application for leave has been given to the company and to any other person the Court may order;
  • The applicant is acting in good faith; and
  • It appears to the Court that it is in the company's best interests for the legal proceeding to be prosecuted or defended.

Ms. Ren named seven current and former directors of EPL as defendants in her draft Notice of Civil Claim. She alleged that they were negligent because they caused EPL to enter into the agreement with Union Goal without conducting sufficient due diligence. Ms. Ren also alleged that Ms. Hu, EPL's former CEO, breached her fiduciary duties to EPL.

EPL argued that the application was an abuse of process because it was essentially the same application that was brought by a different shareholder and had been dismissed in 2538520 Ontario Ltd. v. Eastern Platinum Limited, 2019 BCSC 1446 (the 253 Proceeding). In the alternative, EPL argued that Ms. Ren had not satisfied all statutory prerequisites to her application and in particular, the third and fourth conditions, i.e. whether the applicant is acting in good faith and whether the proposed proceeding is in the company's best interests.

The Court rejected EPL's abuse of process argument for various reasons, including that Ms. Ren's draft claim included allegations against Ms. Hu that were supported by the contents of a resignation letter from a senior officer of EPL's subsidiary (the Lubbe letter). In the letter, Mr. Lubbe identifies examples of conduct that caused him concern, including that he was instructed by Ms. Hu to manipulate certain models regarding the value of the Union Goal transaction and that Ms. Hu, in her role as CEO, directed the negotiations with Union Goal contrary to EPL's interests. Ms. Ren alleged that this conduct was a breach of Ms. Hu's fiduciary duties owed to EPL.

Regarding the fourth criteria of the test for leave, which is the focus of this article, EPL argued that it relied on the recommendations of a special committee which found that it would not be in EPL's best interests to commence proceedings against the proposed defendants and that the Court should defer to the special committees' recommendation.

The Court acknowledged that directors are generally afforded protection if their business decisions fall within a range of reasonable options. This deference to the decision of a company's directors is known as the business judgment rule. Directors' decisions are often informed by reports, financial statements or work done by corporate officers or professional advisors. In this case, EPL's directors deferred to the recommendation of a special committee.

However, the judge found that the business judgment rule did not assist EPL in the circumstances of this case for largely the same reasons as those in the 253 Proceeding: there were gaps in the evidence about the information considered by the special committee in reaching their recommendations.

The Court denied Ms. Ren leave to commence a derivative action against all the directors, but granted her leave to commence an action against one director, Ms. Hu, for breach of fiduciary duty and negligence. EPL appealed this order.

B.C. Court of Appeal decision

At the Court of Appeal, EPL argued that the judge below erred in failing to defer to the special committee's recommendation against proceeding with the proposed action and that this decision should have informed the application of the business judgment rule. EPL argued that the Court should defer to the special committee's recommendation because the members of the committee were independent and properly informed based upon a sufficiently rigorous process and its decision fell within a range of reasonable alternatives. The Court of Appeal rejected this argument.

Justice Skolrood, who issued written reasons for the Court of Appeal, acknowledged that there is no rule requiring a company to produce all documents that were considered or informed a special committee's process, but that it is necessary to provide the Court with enough evidence that enables it to assess the rigor and reasonableness of the special committee's process and conclusions. Justice Skolrood held that both Justice Smith in the 253 Proceeding and Justice Gomery in the decision below concluded that EPL had not met that burden and there was no basis for the Court of Appeal to reach a different conclusion.

In the 253 Proceeding, Justice Smith reviewed an affidavit from Nigel Dentoom, a member of the special committee that was formed prior to the 253 Proceeding. Justice Smith held that Mr. Dentoom did not attach any of the documents referred to in his affidavit as exhibits, nor did he provide detail or further documentation regarding the committee's discussions or assessment of the agreement with Union Goal. Further, Justice Smith found that "the documents and other material that Mr. Dentoom obliquely refers to are entirely within the control of EPL. By not putting any of it into evidence, EPL asks the Court to simply accept on faith the conclusion of the special committee. The deference that the Court should show the special committee does not go that far."

In this proceeding, Justice Gomery reviewed an affidavit from Mr. Dentoom which confirmed his evidence from his affidavit filed in the 253 Proceeding. Justice Gomery also reviewed an affidavit from Mr. Guan, the sole member of the second special committee that was established to consider Ms. Ren's request. The Court found that Mr. Guan's affidavit did not address the gap in evidence that precluded Justice Smith from deferring to the special committee in the 253 Proceeding and accordingly, the Court could not defer to the judgment of the special committee in this action and conclude that the proposed negligence claim is bound to fail.

Justice Skolrood also held that the special committee failed to address the allegations in the Lubbe letter, which diminished any deference that could be shown to the committee's processes and decisions. Since the special committee failed to produce any of the documents it relied upon, both Justice Smith in the 253 Proceeding and Justice Gomery in this action were unable to assess whether the committee meaningfully considered Mr. Lubbe's serious allegations.

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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