Tuesday, 8 May 2012

Failure to Issue Proper Financial Statements and Hold AGMs is Shareholder Oppression

Section 227 of the Business Corporations Act is in many ways the equitable Swiss army knife of corporate law.  Operating on the basis of parties' reasonable expectations rather than pure legal rights, it allows the courts to apply what are essentially equitable principles to ensure that minority shareholders are not treated in a way that is "oppressive" or "unfairly prejudicial".  These are open-ended concepts and impugned conduct can take a myriad different forms, such as exclusion from management, removal as a director, or unfair dilution of holdings, to name just a few.  

In the context of small closely held companies, a particularly common complaint is the failure of the majority shareholder or directors to comply with corporate obligations such as preparing and issuing financial statements in compliance with (s. 199) and holding AGMs (s. 182).  In Red Line Enterprises Ltd. v. Six Mile Pub Ltd., 2012 BCSC 628, the court confirmed that this type of conduct is oppressive and may be remedied by a compliance order against the company and its directors.

The petitioner in this case was a 5% shareholder in the respondent pub and was represented by one of the three directors on the board.  The other two directors represented the majority shareholder and controlled the board.  For reasons not explained, the majority directors stopped complying with the Act by not holding annual general meetings (s. 182), refusing to appoint an auditor (s. 204), and failing to issue proper financial statements reviewed and approved by the board and attaching an auditor's report (s. 199).  These failures formed the basis for the oppression claim brought by the petitioner.

The court considered the impugned conduct and found that it was an instance of "conduct of the affairs of the company in a manner oppressive to one or more of the shareholders" contrary to s. 227(2)(a), rather than an "act done or threatened that would be unfairly prejudicial to one or more of the shareholders" contrary to s. 227(2)(b).  Under this rubric, the court concluded that as long as the petitioner continued to be a minority shareholder, "it [was] perfectly entitled to insist upon compliance with the provisions of the Act in order to protect its continuing minority interest" and "Its proprietary rights demand nothing less."  Accordingly, the court ordered an AGM to be held and financial statements to be produced in compliance with the Act.

In coming to this conclusion, the court appears to have adopted in part the ratio in Discovery Enterprises Inc. v. I.S.E. Research Ltd., 2002 BCSC 1624, where Lowry J. (as he then was) held that a refusal "refusal of the company to deliver audited financial statements can serve to hide the true financial position from a minority shareholder" and therefore is oppressive because it "lacks probity and fair dealing toward the proprietary rights of the minority shareholder."  However, the court held only that financial statements had be prepared in accordance with the Act, which includes, under s. 199, having an auditor's report attached to the financial statement.  The court, specifically refused to pronounce on whether audited financial statements were required.  In this respect, the court did not adopt Discovery Enterprises, finding that, in that case, parties simply conceded that audited financial statements were required. 
There are two additional interesting points about this case.

First, the parties had an option agreement which allowed the minority shareholder to give notice to the majority shareholder that it wished to be bought out.  Despite such notice being given in 2010, the purchase was not completed and the petitioner remained a minority shareholder.  Although finding that the option had no bearing on whether the impugned conduct was oppressive, the court held that it was relevant to the question of remedy, such that no remedies were required for the time period before the option was exercised:
I find that the respondents' argument is, however, relevant to the question of the appropriate remedy.  Red Line's continuing shareholding was not an investment, but was designed to protect its interest in the pub's liquor licence so long as it could not operate the liquor store independently of that licence.  In 2010, that protection was no longer required, triggering Golden Spigot's right to purchase the minority shareholding.  Up to that point (2010), I see no benefit to any party in requiring past obligations to be retroactively met.
It appears that the court concluded that all past misconduct was implicitly released in the petitioner's decision to be bought out.

Second, the petitioner's claim was brought under s. 227 - oppression remedy, as well as s. 228 - which allows the court to issue an injunction to direct a company, shareholder, or director to comply with the Act.  Although this section would have provided an easier avenue to order compliance, it was not considered by the court.