business law case

SAMPLE MID TERM QUESTION Tom Pisson has always loved cars since the time he bought his first - a Datson T42 sports car (this despite the fact that his beloved T42 rusted out and fell apart within three years of purchase). When he was in his twenties he started a new Pisson car dealership by the business name of Pisson’s Nissan which was within five years i ncorporated as Pisson’s Nissan Limited (“PNL”). Tom had a great time with the business as sole shareholder of the company’s 1000 common shares, but by the year 2000 he was looking for other investors so he could expand his showroom and service department. He sold 30% (300) of his common shares to his rich cousin, Bill Bigcheque, 30% (300) to his father -in -law, Bob Lemmon, and 5% (50) to his friend, Ray Close. Tom retained the balance of 35% (350) of the shareholdings. Although the shareholdings were now divided up, Tom continued as the sole director of PNL, and he continued to run the business since the other shareholders were not interested and had very little knowledge of the car business. In fact, the company never has annual shareholders’ or direc tors’ meetings. The shareholders intended but never got around to signing a shareholders’ agreement, but in 1999, because of Tom’s strong desire to remain the largest shareholder, the shareholders passed a resolution providing that if any outside party intended to purchase at least 10% of the common shares in the company then immediately, at the direction and “discretion” of their Board of Directors, PNL could issue 1000 new common shares and sell them for $10 apiece to any of the existing shareholders ( the “poison pill”).

In the last five years the following events have occurred: 1. In 2010 Tom purchased a Colville painting for $400,000 which hangs in his new home in Wilful, Nova Scotia, and expensed it to PNL; 2. In 2011 he incorporated a management compan y, Pisson Management Incorporated (“PMI”), and PNL pays management fees to PMI at twice the market value. Tom is the sole shareholder and director of PMI; 3. In 2012 Tom sold the lands on which the dealership is located to PMI and now PNL pays PMI monthly rent at three times the market rate; 4. In 2013 Tom was given a $200,000 bonus by PNL despite the fact that PNL suffered a net loss for the fiscal year ending on December 31, 2002; 5. In 2014 Tom hears a rumour from a friend that Bart Blow, a local millionaire , wants to buy Bill Bigcheque’s shares in PNL, so Tom immediately initiates the issuance of 500 new common shares of PNL which he then immediately purchases, giving Tom approximately 56% control of PNL. Bill, Bob and Ray are suddenly told by PNL’s corporate solicitor that Tom now owns 56% of PNL. They are angry and surprised. They are even more upset after their accountant reviews the financial records of PNL and advises them of the above-mentioned even ts. They go to you, the best corporate litigation lawyer in the Province, and they want to know their legal remedies, if any, in these circumstances. Please provide them with an opinion letter and consider all possible arguments and issues. SUGGESTED ANSWER TO MID TERM SAMPLE QUESTION There are a number of legal issues raised by your situation, but the primary point or issue is whether Tom, as the sole director of PNL, has a fiduciary duty to the corporation. There is no question that a director owes a fiduciary duty and a duty of care to the corporation in question. The duty of care is somewhat similar to a duty of care in negligence law, but an important qualifier is that the duty of care in corporation law is subject to the qualifier that a director will not be held responsible or liable as long as he has provided and made a reasonable judgment call in dealing with the corporation’s business affairs. This is called the “business judgment rule.” More specifically, there is no need to exhibit greater skill than in the context of the director’s knowledge and experience, and the director does not have to give his continuous attention to the company and, in the absence of reasonable suspicions, may entrust and delegate corporate responsibilities to others within the corporate enterprise. The fiduciary obligation of a director to the corporation is to exercise utmost good faith and honesty in the administration of his responsibilities, and not to put himself in a position where there is a conflict of inter est or where the director could and does take advantage of any corporate opportunities to his advantage: Can -Aero.

The so -called “Revlon duty,” established in an American court decision, suggests that the fiduciary duty and duty of care of a director can change depending on the circumstances and, for example, when the corporation is subject to some form of takeover bid, then there is a point in time when the director’ responsibilities and obligations to the corporation shift or change to a magical point in time when the directors’ interests should be to try to maximize shareholder value. In Canada, based on the decisions of our Supreme Court of Canada in Peoples Department Stores v. Weise, and also the BCE decision, that the Revlon duty does not exist, as a general principle, in Canada. Peoples v. Weise establishes that to act in the best interests of a corporation, a director or board of directors must consider and take into account a number of circumstances and considerations, and specifically the interests of a number of stake holders such as shareholders, employees, suppliers, creditors, consumers, governments, and even the environment.

In BCE, the Supreme Court of Canada endorsed the “good corporate citizen” principle which emphasized that a director’ s duty of care and fiduciary duty is to the corporation, and not a particular constituency, but that what is in the best interest of the corporation should take into account a broader view of all relevant stakeholders. It is also important to note that if a director breaches their duty of care and/or fiduciary duty to a corporation, then individual shareholders do not have the standing to take action on behalf of the corporation unless they do it through what is called a derivative action or proceeding. The only circumstances where an individual shareholder can maintain an individual cause of action against a director would be where that director or board of directors has taken action which singles them out and which causes specific and special damages to them. In view of the above -mentioned principles, and some others, I am going to consider each of the different events or actions that Pisson has taken in the past five years: 1. Tom has improperly expensed the purchase of the Colville painting to the compan y, and it appears that this action goes well beyond unintentional conduct and is a deliberate attempt to improperly expense a personal purchase to the corporation. In my opinion, this represents a breach of fiduciary duty to the corporation since Tom should have made it clear as to his intent to purchase the painting. Furthermore, this is a huge expense, not for the company’s benefit, which undoubtedly had an important impact on the company’s bottom line and net revenue for that particular fiscal year. T here may be a practical solution to this problem since, depending on the circumstances, Colville paintings usually increase in value, and therefore I would suggest a demand letter to Tom requesting that he immediately provide the company with actual posses sion of the painting in question, and as a solution we should explore the possibility of selling the painting at an increase in value; 2. It appears that there is a sweetheart deal between PMI and the corporation. It also appears that you were unaware of the incorporation of this management company, and the fees that were being paid. One specific solution to this problem would be to call a special shareholders’ meeting and pass a resolution requiring repayment of the over charge from PMI to PNL and appropria te adjustment in the accounting records. Although there is no question that this is a potential breach of fiduciary duty and duty of care on the part of Tom, before taking any steps you should investigate, from an accounting perspective, as to how best to make this financial adjustment between these two companies. Obviously since the company expensed these over -charged management fees, they probably paid less income tax during the relevant years, and consequently there may be another less intrusive means of solving this particular problem or making this adjustment; 3. Based on reasonable inquiries, you should have become aware of the sale of the lands on which the dealership is located. This would require a special resolution on the part of the shareholders of the corporation, and therefore by selling the land to PMI it is not only a violation of the internal articles of the corporation, but also a breach of fiduciary duty and duty of care to the corporation. It also seems likely that the “indoor management rule” would not apply to these circumstances since Tom was fully aware or should have been fully aware of the fact that such a sale was contrary to the articles of PNL; 4. On the face of it this again appears to be a breach of a duty of care and fiduciary obligation of Tom to the corporation, but the reason and purpose behind the bonus should be investigated since it may have resulted in less income tax being paid by the corporation, and there may be other ways to adjust this particular item in the future to m inimize the effects from a tax perspective; and, 5. Tom’s purported use of the “poison pill” resolution of the board of directors is, in our opinion, an abuse of that resolution and not in accordance with the resolution. The wording of the resolution indicat es that the poison pill is only triggered “if any outside party intends to purchase at least 10% of the common shares.” In this situation Mr. Blow has not expressed any specific intent to purchase, but it appears that Tom’s actions in triggering the resol ution are based on a “rumour” only and not sufficient to justify the poison pill. It also appears that triggering the poison pill was simply done for the ulterior purpose of taking over, once again, majority control of PNL. It also appears that the issua nce of additional capital, which was not in accordance with the poison pill resolution, would violate the common law pre -emptive rights of other shareholders in these circumstances. The types of remedies that you want in these circumstances really depends on whether you want to continue with this company or want to be bought out, or if you want to buy Tom out once the proper amount of shareholdings is corrected. As mentioned, any action in these circumstances will have to be taken on the company’s behalf, and therefore a derivative action is necessary. Based on the above assessment, there does not appear to be any special damage to any particular shareholder but the corporation in general has been prejudiced by Tom’s actions. Therefore, a derivative actio n is necessary. If the intent of the existing shareholders is to be bought out by Tom (based on the percentage of shareholdings existing prior to the improper triggering of the poison pill), then they can take an oppression remedy under the Third Schedule of the Companies Act , and point to the above incidents as being oppressive conduct and request as a remedy that they be bought out a reasonable market price. However, before doing so I would suggest that we informally approach Mr. Pisson with our findings and seek some internal solution to the problem. If he is unwilling to budge then we may have to take the above proceedings to enforce your rights. Another alternative is to formally call a special shareholders meeting and pass appropri ate resolutions.

One further option would be the winding up of the company, but this may have serious and adverse tax consequences and therefore we should avoid that at all costs unless everything else fails. Certainly the sale of the dealership lands woul d trigger appraisal rights, which could result in the buyout of your shares by Tom, but there are timelines for taking an appraisal remedy or enforcing appraisal rights and since that particular event occurred in 2012 we are out of time. One issue that com es up is whether your neglect in knowing what has gone on over the past five years, until just recently, would prejudice your ability to get a remedy in this situation. In other words, is there some form of contributory negligence that could apply to thes e circumstances because of your inadvertence in monitoring Tom’s behaviour? I can find no authority which would indicate that you could be “contributorily negligent” in these kinds of situations that would limit the remedies that you could exercise in a s ituation like this. One of the great benefits of being a shareholder is that you can be a passive owner and not involved in the corporation’s affairs, and you quite rightfully entrusted the proper operation and management of the company to Tom.