D&O Issues for Closely Held Corporations

Simon Bieber

Emerging Issues in Directors’ andOfficers’ Liability 2013

Law Society of Upper CanadaMarch 4, 2013

OVERVIEW

- Oppression Actions are becoming more and more common to resolve disputes in closely held corporations

- Part of the reason is that oppression and the remedies available are flexible and designed to promote “fairness”

Oppression

- Since the Supreme Court’s decision in BCE Inc. v. 1976 Debentureholders, the Courts have used a two part test for oppression

- The first part of the test requires a plaintiff to establish a “reasonable expectation”

- The second part of the test requires a plaintiff to establish that the “reasonable expectation” has been breached by oppressive conduct

“Reasonable Expectations”- To determine whether there is a

“reasonable expectation”, the Court will look at a number of factors, including:

- general commercial practice- the nature of the corporation, - the relationship between the parties, - past practice, - steps the claimant could have taken to

protect itself, - representations and agreements, and - the fair resolution of conflicting

interests between corporate stakeholders.

Breach of “Reasonable Expectations”

- The second part of the test requires some showing of oppressive or unfair conduct

- Oppressive conduct has been described in the case law as “burdensome, harsh and wrongful,” “a visible departure from standards of fair dealing”, and an “abuse of power” with respect to how the corporation’s affairs are being conducted

Remedies

- Upon finding that the two part test has been satisfied, the Court has a great deal of flexibility to craft appropriate remedies (see section 248 of the OBCA)

- Some of the remedies used in recent decisions include, removal of directors, compensation orders, damages, an order requiring shares to be sold

Recent Trends

- One of the more recent trends for litigation involving closely held companies arises from the use of “shotgun” clauses

- This litigation usually involves closely held corporations that are controlled by a few individuals who are each a shareholder (owner), officer (manager) and director of the corporation

“Shotgun Clauses”

- A “shotgun” clause in a shareholders’ agreement allows a shareholder to offer to buy the shares of other shareholders at whatever price is in the offer

- The recipient of the offer can either (i) accept the offer or (ii) flip the offer around and purchase the shares of the offeror at the price contained in the offer

Purpose of Shotgun Clauses

- The purpose of shotgun clause is to address the situation when there is a breakdown in the relationship of those who own a corporation

- In closely held corporations, this avoids a stalemate when the few individuals who own and control the corporation can no longer get along

- Without a shotgun clause or other mechanism to resolve a stalemate, the corporation may have to be wound up

Litigation Arising from Shotgun Offers

- Recently, there have been a number of lawsuits arising from shotgun offers

- Usually commenced by the shareholder who is unhappy that his/her shares have been acquired

- The defendants usually include the corporation, the other shareholders and the officers and directors

Causes of Action

- The two most common causes of action that are asserted against directors are breach of fiduciary duty and oppression

- Typically, the allegation is that the director improperly misled the shareholder about some aspect of the offer (e.g. about the nature of the financing behind the offer), or that the director worked with the offeror in making the offer to the detriment of the recipient of the offer

Duties- Court have uniformly concluded that there

are no fiduciary duties and no duty of good faith that are owed to the recipient of the offer

- This means that officers/directors can assist in making the offer, share corporate information with potential lenders and participate in creating future business plans for the corporation if the offer is successful

- However, the directors’ duties to the corporation continue, i.e. the director must ensure that he/she does not usurp corporate opportunities or use corporate assets for personal benefit

Oppression

- Courts have found that the “reasonable expectations” in the context of shotgun offers are “bench-marked” by the shareholder agreement

- Accordingly, if conduct is not required/ prohibited by the shareholder agreement, there is likely no “reasonable expectation”

- Specific examples where Courts have held there to be no “reasonable expectation” are (i) an allegation that shares could only be acquired at fair market value or (ii) that shotgun offer could only be made using “conventional funding”

Summary

- It is difficult to establish oppression or breach of fiduciary duty when offer is made in strict compliance with the shareholder agreement

- Directors still have duties to the corporation

- Directors should ensure that recipient of the offer has access to corporate records in order to evaluate the offer