| The legal matters discussed here are based on the | | | | disputes involving the rights of minority shareholders |
| Ontario Business Corporations Act and court decisions | | | | are referred to arbitration even when there is a |
| decided in Ontario and under similar legislation across | | | | mandatory arbitration clause. Where there is a claim |
| Canada. Most businesses are incorporated because | | | | for "oppression" under the Business Corporations Act, |
| of the benefits of limiting liability and potential tax | | | | a minority shareholder may be permitted by the Court |
| savings. Most businesses have more than one owner | | | | to continue his or her lawsuit even though the |
| or shareholder. The relationship among the | | | | unanimous shareholders agreement contains a |
| shareholders can spawn considerable disagreement. In | | | | mandatory arbitration clause. |
| a surprisingly large number of cases, the disputes | | | | Oppression Remedy |
| among shareholders can lead to angry and | | | | Under the Ontario Business Corporations Act, a |
| complicated litigation with uncertain outcomes. In this | | | | minority shareholder is entitled to "relief from |
| article, we discuss the legal issues which arise among | | | | oppression" when his or her reasonable legitimate |
| shareholders of private corporations, typically with | | | | expectations from the majority shareholders have not |
| fewer than 10 shareholders. | | | | been met. Legitimate expectations are found by |
| A business corporation exists because one or more | | | | looking at the articles of incorporation, the by-laws, the |
| people have decided to set it up. There are hardly any | | | | resolutions of the directors and the shareholders and |
| impediments to incorporating a new corporation under | | | | the unanimous shareholders agreement, including any |
| Canadian law. In most Canadian provinces, any person | | | | amendments of it and by general commercial and |
| over 18 years of age who is of sound mind and not | | | | business practices. |
| bankrupt, may incorporate a company simply by | | | | For example, if the shareholders were accustomed to |
| signing articles of incorporation and presenting them to | | | | receiving an annual dividend but the dividend is not |
| the appropriate government ministry for stamping and | | | | distributed fairly or not at all without reasonable |
| registration. A corporation has a legal personality | | | | justification, a court might find this change oppressive. If |
| independent of its owners and managers. A | | | | majority shareholders conceal information about the |
| corporation can carry on business; file tax returns; | | | | business from the minority shareholders by excluding |
| borrow or lend money; and can sue and be sued. | | | | the minority shareholder from decision-making or |
| Shareholder disputes revolve around how the owners | | | | falsifying documents, that is also oppressive to the |
| and managers of corporations deal among | | | | minority. |
| themselves. | | | | Another example of oppression might occur if the |
| Who runs a corporation? | | | | majority shareholders act in a way which violates the |
| The people who have authority to make decisions for | | | | terms of the unanimous shareholders agreement. In |
| a business corporation fall into three categories: | | | | some corporations, the removal of a minority |
| 1. Officers: The President and the Secretary are the | | | | shareholder from his or her position in the management |
| only officers who must be appointed but most | | | | of the corporation could be an act of oppression by |
| corporations also have a Vice-President and a | | | | the majority. Each of these examples has its roots in |
| Treasurer. Other titles, such as CEO, COO and CFO | | | | unfair behaviour by the majority which runs contrary to |
| are descriptive but are not required by law. The | | | | the reasonable expectations of the minority |
| officers manage the day-to-day business of the | | | | shareholder as a shareholder, employee or creditor of |
| corporation. The officers usually delegate some of | | | | the corporation. Typically, there is more than just a |
| their authority to other employees. The officers report | | | | single incident. The majority shareholders are usually |
| to the Board of Directors. In a private business | | | | looking to remove the minority shareholder from the |
| corporation, the officers, directors and shareholders | | | | business or take financial advantage of the minority. |
| overlap or may even be the same people. | | | | While the aggrieved shareholder usually holds only a |
| 2. Directors: The legal management of a business | | | | minority of the shares, the remedies discussed in this |
| corporation is in the hands of the directors. The | | | | article are available to any shareholder who can show |
| number of directors is designated by the Articles of | | | | that he or she has been oppressed by another |
| Incorporation and can range from one to any number | | | | shareholder. |
| agreed to by the shareholders. The directors pass | | | | What can the Court do if it finds that a shareholder |
| resolutions concerning legal and business matters | | | | has been oppressed? |
| affecting the corporation. Directors' resolutions are | | | | The oppression remedy is a powerful remedy for a |
| passed by majority vote but some resolutions, such as | | | | minority shareholder to obtain redress for unfair |
| a decision to sell the entire business require a larger | | | | conduct by the majority. If a judge finds the conduct of |
| majority such as 75% or even unanimity. Each director | | | | the majority shareholder to be oppressive, an order |
| has one vote. Typical resolutions include (1) banking and | | | | can be made to rectify the oppression in the most |
| borrowing; (2) hiring of accountants or auditors and | | | | efficient way. This can be done by 1) the payment of |
| legal counsel; (3) approval of the actions taken by | | | | money, 2) by directing the majority to buy the |
| officers; (4) approval of financial statements; and (5) | | | | aggrieved shareholder's shares for a reasonable price |
| acquisition of a new business or senior employee. The | | | | (as determined by professional valuation), 3) by |
| types of resolutions are determined by the | | | | reinstating the aggrieved shareholder to his or her |
| circumstances of the corporation. | | | | former position in the business, or 4) by holding an |
| At every meeting of the directors, there must be a | | | | auction at which all of the shareholders have the right |
| quorum. A quorum is the minimum number of directors | | | | to purchase shares of the corporation. A judge also |
| required in person or by proxy to constitute a valid | | | | has the power to cancel the exercise of a "shotgun" |
| meeting. This is determined by agreement between | | | | buy-sell if the court finds that it has not been exercised |
| the shareholders of the corporation and is set out in | | | | fairly. The appropriate remedy will depend on the |
| the corporation's by-laws. If no quorum exists, business | | | | circumstances of the corporation. |
| conducted at the meeting is not valid. The method of | | | | A Court's decision to remedy oppression is intended to |
| giving notice of a directors' meeting is also important. If | | | | compensate the minority shareholder not to punish the |
| the directors are all in agreement and the business of | | | | majority. However, if the Court finds that the majority |
| the meeting is routine, a meeting may not be | | | | shareholder has acted fraudulently or has breached his |
| necessary. All of the business can be done by each of | | | | fiduciary duty to the minority shareholders, punitive and |
| the directors signing resolutions prepared by the | | | | other damages can also be awarded. When a court |
| corporation's lawyer. | | | | finds oppression, the share value attributed to the |
| If there are contentious issues, written notice of the | | | | minority shareholder is not subject to a minority |
| directors' meeting has to be sent, usually 10 days in | | | | discount as it might be if the minority shares were sold |
| advance, by the method prescribed by the by-laws of | | | | in a commercial transaction. |
| the corporation. The notice of the meeting has to give | | | | Breaches of fiduciary duty can include the failure of |
| each director enough information and documents | | | | the majority shareholder to provide full, fair and frank |
| about each topic to be discussed so that he or she | | | | disclosure of all matters affecting the corporation's |
| can make an informed decision about it. The | | | | business. If one or more shareholders has removed |
| resolutions of the directors have to be approved or | | | | assets, income or business of the corporation or is |
| ratified by the shareholders of the corporation. | | | | competing with the corporation, that may also be a |
| Directors are not required to attend a meeting but if a | | | | breach of fiduciary duty in addition to oppression. |
| director's failure to attend prevents the meeting from | | | | What other remedies are available? |
| proceeding due the lack of a quorum, the corporation's | | | | The Court also has the power to order that a |
| business may be hampered and the Court may order | | | | directors' or shareholders' meeting take place for the |
| that a meeting be held without a quorum. | | | | purpose of conducting specific business affecting the |
| 3. Shareholders: The owners or shareholders are the | | | | corporation. The Court can also authorize the |
| final decision-makers about issues affecting the | | | | commencement of a derivative action. This is a lawsuit |
| business of the corporation. Resolutions of the | | | | by the corporation against a "rogue" shareholder. For |
| directors have to be approved by the shareholders. | | | | example, if the majority shareholder has improperly |
| As with directors' meetings, a quorum is required for a | | | | taken some of the assets out of the corporation or |
| valid shareholders' meeting and notice must be given in | | | | has spent the corporation's money without authority, |
| writing with enough information and documents about | | | | the corporation will have to sue the rogue. Of course, |
| each issue to enable the shareholders to make an | | | | the rogue shareholder will not authorize a lawsuit |
| informed decision. Unlike directors, who have one vote | | | | against himself. In such a case, the court can authorize |
| each, shareholders have one vote for each voting | | | | another shareholder to start and manage a lawsuit in |
| share of the corporation he or she holds. (Some of the | | | | the corporation's name against the rogue shareholder. |
| shares may be owned by another corporation but the | | | | The Court also has the power to order an investigation |
| concept is the same). | | | | of the financial affairs of the corporation by a |
| The ownership of the corporation will be determined | | | | court-appointed auditor. In the most extreme cases, |
| by the business partners. Sometimes, the ownership is | | | | the Court can direct that the corporation be wound up |
| driven by the amount of money a shareholder invests. | | | | on the basis that it is "just and equitable" to do so. A |
| In other cases, some shareholders provide special | | | | "just and equitable winding-up" means that the court |
| expertise or attract business, while others provide | | | | directs that the business be sold, perhaps to one or |
| financing, and these elements may warrant an | | | | more shareholders and that the assets of the |
| ownership share of the corporation. Some | | | | corporation, net of any liabilities, be divided among the |
| corporations reward a loyal employee with a minority | | | | shareholders. Special circumstances must exist for this |
| shareholding. Some corporations have silent | | | | remedy to be considered by the court, including a |
| shareholders, who are not active in the daily business | | | | deadlock among shareholders, which are paralyzing |
| but own part of the corporation and therefore have a | | | | the corporation. |
| vote at shareholders' meetings. | | | | What happens in shareholder litigation? |
| Shareholders are entitled to receive the financial | | | | These litigation procedures described above require |
| statements of the corporation and to examine the | | | | detailed evidence and strategic considerations by an |
| books and records at the corporation's head office. If | | | | experienced shareholders' dispute lawyer. Apart from |
| there are more than five shareholders, the | | | | the evidence of the minority shareholder, the value of |
| corporation's financial statements have to be audited | | | | the business has to be determined. This process is |
| unless the shareholders vote to waive an audit. | | | | always more complicated than it appears to a lay |
| The most important aspect of share ownership is | | | | person. The valuation of a business is a specialized skill |
| "control". A shareholder or group who owns the | | | | provided by a chartered business valuator, a chartered |
| majority (more than 50%) of the voting shares will be | | | | accountant with valuation training. Before valuing the |
| in position to control the activities of the corporation | | | | shares, the valuator may have to assess whether the |
| subject to certain restrictions agreed among all the | | | | majority shareholders have removed some money or |
| shareholders or imposed by law. Some shareholder | | | | assets from the corporation unfairly, whether by fraud |
| decisions, such as the sale of the entire business of | | | | or by misuse of the funds for an unauthorized purpose. |
| the corporation require a higher majority or even | | | | There are also income tax considerations. The value |
| unanimity. | | | | of shares is affected how shares are sold. If the |
| Minority shareholders have to live with the fact that the | | | | corporation redeems the shares for cancellation, the |
| majority shareholders have a right to run the | | | | shareholder will receive a taxable dividend. If the |
| corporation even if the minority disagrees. However, | | | | shares are purchased by another shareholder, the |
| the majority must comply with the terms of a | | | | selling shareholder may be able to claim an exemption |
| unanimous shareholders agreement, if one exists, and | | | | from capital gains taxes. There are also other tax |
| treat the minority shareholders fairly. The majority | | | | issues. Advice from a tax accountant or lawyer is |
| shareholders are not permitted to "oppress" the | | | | required to identify the most efficient way to dispose |
| minority shareholders. | | | | of the shares. This creates further disagreement |
| Rights of Shareholders | | | | because a tax arrangement beneficial to the seller will |
| Shareholders have three basic rights: 1) The right to | | | | be less favorable to the buyer. |
| vote at valid shareholders' meeting after receiving | | | | These remedies take some time to implement. The |
| proper notice and documents; 2) The right to attend a | | | | trial of a shareholders' dispute lawsuit will not take |
| meeting of shareholders; and 3) the right to accurate | | | | place for many months or even years after it is |
| and complete information about the affairs of the | | | | commenced. Therefore, the court also has the power |
| corporation, including the articles of incorporation and | | | | to grant interlocutory or temporary relief to ensure that |
| any amendments, the directors' register, the by-laws, | | | | the interests of the minority shareholders are |
| minutes of directors and shareholders' meetings and | | | | preserved until the trial or hearing. The Court's |
| the financial statements, whether audited or not. When | | | | objective is to preserve the current situation without |
| these rights are not respected, a shareholder may | | | | pre-judging the case. |
| have a right to sue the shareholders who failed to | | | | Shareholder litigation is often characterized by hard |
| respect the rights of the minority. | | | | feelings among the disputing shareholders. These are |
| Unanimous Shareholders Agreement | | | | people who were in business together and their |
| Even though it is not required by law, many | | | | relationship has soured. It is much a like a divorce. Each |
| shareholders make a unanimous shareholders | | | | side proceeds to gather its evidence which supports |
| agreement which sets out the ground rules for the | | | | or denies the existence of oppression and other |
| operation of the corporation. Shareholder agreements | | | | offensive conduct. Valuation of the shares may also |
| can cover a wide variety of topics including but not | | | | be complicated by lack of proper disclosure and |
| limited to: | | | | accounting issues. We have seen cases where the |
| 1) the management positions and responsibilities of the | | | | majority shareholders "stonewall" by refusing to |
| shareholders; | | | | provide proper information. This makes the litigation |
| 2) the method for valuing the shares of the | | | | more time-consuming. |
| corporation; | | | | Amid the hard feelings and expense involved in these |
| 3) the method for adding or removing shareholders for | | | | kinds of cases, lawyers in this field keep their eye on |
| misconduct, death or inability to function in the | | | | opportunities to make a settlement. While many |
| management of the business; | | | | shareholder dispute cases go to trial, the great majority |
| 4) the mechanism for valuation and sale of the whole | | | | of them settle before the trial through direct |
| business of the corporation; | | | | negotiations or mediation. Settlements are driven by |
| 5) the method for determining management salaries, | | | | the uncertainty of the outcome and the effort of all |
| bonuses and dividends; | | | | parties to limit legal and accounting expenses. |
| 6) non-competition and non-solicitation clauses to | | | | A settlement may also be more efficient for income |
| prevent a departing shareholder from taking a key part | | | | tax purposes than a court judgment. Uncertainty |
| of the corporation's business and thereby damaging | | | | relates not only to whether the Court will find the |
| the corporation and its remaining shareholders; | | | | majority shareholders' conduct oppressive but also the |
| 7) a buy-sell provision, sometimes called a "shotgun" | | | | disagreement between the valuation experts for each |
| clause, which permits a shareholder to offer to buy the | | | | side. Valuation of shares is as much art as it is |
| shares of the other shareholders subject to the right | | | | accounting and valuators may disagree radically on |
| of these other shareholders to the offering shares at | | | | how much the corporation's shares are worth. |
| the same price; | | | | What should I do if I think the majority shareholder is |
| 8) succession arrangements to spouses or the next | | | | oppressing me? |
| generation upon death or disability of a shareholder; | | | | The first step to take is to fully document all events as |
| 9) life insurance on key management employees and | | | | promptly as possible after they occur. Make notes and |
| shareholders; | | | | send emails but care must be taken not to make |
| 10) the special majority or unanimity required for certain | | | | statements which could adversely affect a minority |
| types of corporate decisions such as the sale of the | | | | shareholder's position. Timing is important for notices of |
| whole enterprise of the corporation or commencing a | | | | meetings and buy-sell notices. Delay in obtaining legal |
| new enterprise; and | | | | and financial advice could have a very significant |
| 11) dispute resolution including arbitration and choice of | | | | impact on the eventual result. If you get written notice |
| law provisions. | | | | of shareholders or directors meeting without details of |
| Shareholder Disputes and Arbitration | | | | the matters to be discussed, you may not be able to |
| The dispute resolution clause of a unanimous | | | | complain about an adverse vote if you fail to complain |
| shareholders agreement usually provides that all | | | | about it in advance and just attend and vote. |
| disputes among the shareholders are to be resolved | | | | If events are happening in the business which are |
| by arbitration and not by the courts. It typically states | | | | being concealed from a minority shareholder or if |
| where the arbitration will be held. If all the parties are in | | | | financial information is being hidden, prompt action is |
| Ontario, Ontario law will apply. If some parties are | | | | necessary. First, you must ensure that no damage is |
| located elsewhere, the arbitration clause may specify | | | | done to the business. Second, if you delay in taking |
| which law, i.e., of which province or country, is | | | | legal steps or in having your lawyer write a letter to |
| applicable. There may also be reference to the | | | | the majority shareholders to complain of the offensive |
| procedural rules and the method for selecting the | | | | action, you may be taken to have approved of the |
| arbitrators. | | | | improper acts of the majority shareholders. The best |
| Courts in Ontario give a very high degree of respect | | | | advice is to get legal advice as soon as possible. |
| to a dispute resolution clause which requires all | | | | July 2009. © Igor Ellyn and Orie Niedzviecki. |
| disputes to be resolved by arbitration. However, not all | | | | |