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The Court's Requirement of Good Faith in a Derivative Action

October 26, 2021

British Columbia

,

Canada

Issue

When may a shareholder bring a derivative action?

Conclusion

On an application for leave to bring a derivative action under the Business Corporations Act, the court must consider the following factors:

(a) the complainant has made reasonable efforts to cause the directors of the company to prosecute or defend the legal proceeding,

(b) notice of the application for leave has been given to the company and to any other person the court may order,

(c) the complainant is acting in good faith, and

(d) it appears to the court that it is in the best interests of the company for the legal proceeding to be prosecuted or defended (s.233). (Business Corporations Act)

The requirement that the complainant be acting in good faith focuses on the primary purpose for the bringing of the derivative action. The primary purpose must be to benefit the company. The onus is on the applicant to provide evidence proving this question of fact. Good faith cannot simply be presumed, even where the claim can be said to be in the best interests of the company. The evidence that may be considered by the court in determining the good faith requirement includes the applicant's stated belief in the merits of the proposed action. If this evidence is accepted by the court, it is a prima facie indication of good faith, but it is not necessarily determinative. The court must also consider evidence that indicates the applicant has ulterior motives, including considering any existing disputes between the parties. A conclusion that there is an absence of "good faith" simply means that the applicant has not met the onus of showing that the primary purpose of the action is to benefit the company. There is no requirement that the respondent show the applicant is acting in bad faith. (2538520 Ontario Ltd. v. Eastern Platinum Limited)

The question of whether it appears to the court to be in the best interests of the company to prosecute the action includes consideration of the merits of the proposed action. In this regard, the court should consider whether the proposed action has a reasonable prospect of success or is bound to fail and whether the defence is bound to be accepted. (2538520 Ontario Ltd. v. Eastern Platinum Limited)

So long as the proposed action is prima facie in the interests of the corporation and is not designed to harass and embarrass the proposed defendants then the court should facilitate the resolution of the dispute (A E Realisations (1985) Ltd. v. Time Air Inc.)

With respect to the intersection between the oppression remedy and derivative action provisions, where the shareholder cannot show they were affected by the alleged misconduct in a way different from any other shareholder, the claims would have to be pursued by the corporation itself through a derivative action rather than an application under the oppression remedy provisions. (Pasnak v. Chura)

In A E Realisations (1985) Ltd. v. Time Air Inc., a creditor of a dissolved (and subsequently revived) corporation brought a successful application for leave to bring a derivative action on behalf of the corporation against the second corporation/major shareholder of the dissolved corporation, which had assumed the assets and liabilities of the first corporation prior to dissolution. This case was decided pursuant to the Canada Business Corporations Act, R.S.C. 1985, c. C-44.

Law

Sections 232 and 233 of the Business Corporations Act, SBC 2002, c 57 gives the court powers in relation to derivative actions:

Derivative actions

232 (1)In this section and section 233,

"complainant" means, in relation to a company, a shareholder or director of the company;

"shareholder" has the same meaning as in section 1 (1) and includes a beneficial owner of a share of the company and any other person whom the court considers to be an appropriate person to make an application under this section.

(2)A complainant may, with leave of the court, prosecute a legal proceeding in the name and on behalf of a company

(a)to enforce a right, duty or obligation owed to the company that could be enforced by the company itself, or

(b)to obtain damages for any breach of a right, duty or obligation referred to in paragraph (a) of this subsection.

(3)Subsection (2) applies whether the right, duty or obligation arises under this Act or otherwise.

(4)With leave of the court, a complainant may, in the name and on behalf of a company, defend a legal proceeding brought against the company.

Powers of court in relation to derivative actions

233 (1)The court may grant leave under section 232 (2) or (4), on terms it considers appropriate, if

(a)the complainant has made reasonable efforts to cause the directors of the company to prosecute or defend the legal proceeding,

(b)notice of the application for leave has been given to the company and to any other person the court may order,

(c)the complainant is acting in good faith, and

(d)it appears to the court that it is in the best interests of the company for the legal proceeding to be prosecuted or defended.

(2)Nothing in this section prevents the court from making an order that the complainant give security for costs.

(3)While a legal proceeding prosecuted or defended under this section is pending, the court may,

(a)on the application of the complainant, authorize any person to control the conduct of the legal proceeding or give any other directions for the conduct of the legal proceeding, and

(b)on the application of the person controlling the conduct of the legal proceeding, order, on the terms and conditions that the court considers appropriate, that the company pay to the person controlling the conduct of the legal proceeding interim costs in the amount and for the matters, including legal fees and disbursements, that the court considers appropriate.

(4)On the final disposition of a legal proceeding prosecuted or defended under this section, the court may make any order it considers appropriate, including an order that

(a)a person to whom costs are paid under subsection (3) (b) repay to the company some or all of those costs,

(b)the company or any other party to the legal proceeding indemnify

(i)the complainant for the costs incurred by the complainant in prosecuting or defending the legal proceeding, or

(ii)the person controlling the conduct of the legal proceeding for the costs incurred by the person in controlling the conduct of the legal proceeding, or

(c)the complainant or the person controlling the conduct of the legal proceeding indemnify one or more of the company, a director of the company and an officer of the company for expenses, including legal costs, that they incurred as a result of the legal proceeding.

(5)No legal proceeding prosecuted or defended under this section may be discontinued, settled or dismissed without the approval of the court.

(6)No application made or legal proceeding prosecuted or defended under section 232 or this section may be stayed or dismissed merely because it is shown that an alleged breach of a right, duty or obligation owed to the company has been or might be approved by the shareholders of the company, but evidence of that approval or possible approval may be taken into account by the court in making an order under section 232 or this section.

In 2538520 Ontario Ltd. v. Eastern Platinum Limited, 2020 BCCA 313 (CanLII), the petitioner was a shareholder of the respondent corporation. The respondent had entered into an agreement with a third party in respect of a mining project in South Africa. The shareholder alleged that all the proceeds of the project were to go to the third party, which would leave the respondent corporation bankrupt. The shareholder's application for leave to bring a derivative action against the directors of the respondent corporation for breach of fiduciary duty was dismissed on the basis that the shareholder failed to prove that he was acting in good faith.

The Court of Appeal upheld the application judge's decision, which decision focused on the requirements of good faith and the best interests of the company:

Good Faith Requirement

29 The requirement that the complainant be acting in good faith focuses on the primary purpose for the bringing of the derivative action. The primary purpose must be to benefit the company. The onus is on the applicant to provide evidence proving this question of fact: Jordan Enterprises Ltd. v. Barker, 2015 BCSC 559 (B.C. S.C.) at paras. 27 — 30.

30 The good faith requirement is a separate requirement that must be established by the complainant based on evidence. It cannot simply be presumed, even where the claim can be said to be in the best interests of the company: Discovery Enterprises Inc. v. Ebco Industries Ltd. (1997), 40 B.C.L.R. (3d) 43 (B.C. S.C.) at paras. 117 — 118 [Discovery Enterprises (S.C.)]; aff'd, (1998), 50 B.C.L.R. (3d) 195 (B.C. C.A.) at para. 5 [Discovery Enterprises (C.A.)].

31 The evidence that may be considered by the court in determining the good faith requirement includes the applicant's stated belief in the merits of the proposed action. If this evidence is accepted by the court, it is a prima facie indication of good faith, but it is not necessarily determinative: Jordan Enterprises at para. 29; Discovery Enterprises (S.C.) at para. 117. The court must also consider evidence that indicates the applicant has ulterior motives, including considering any existing disputes between the parties.

32 A conclusion that there is an absence of "good faith" simply means that the applicant has not met the onus of showing that the primary purpose of the action is to benefit the company. There is no requirement that the respondent show the applicant is acting in bad faith.

33 A finding of good faith, or of a failure to prove good faith, is a finding of fact in the purview of the trial judge, typically based on inferences drawn from the record, and the appeal court will not interfere absent a palpable and overriding error: Housen v. Nikolaisen, 2002 SCC 33 (S.C.C.) at para. 10; Discovery Enterprises (C.A.) at para. 7.

Best Interests Requirement

34 The question of whether it appears to the court to be in the best interests of the company to prosecute the action includes consideration of the merits of the proposed action.

35 In this regard, many of the authorities have adopted the language of Tysoe J. (as he then was) in Primex Investments Ltd. v. Northwest Sports Enterprises Ltd. (1995), 13 B.C.L.R. (3d) 300 (B.C. S.C. [In Chambers]) [Primex (S.C.)], var'd, (1996), 26 B.C.L.R. (3d) 357 (B.C. C.A.), leave to appeal ref'd [1997] S.C.C.A. No. 4 (S.C.C.). He held that the court should consider whether "the proposed action has a reasonable prospect of success or is bound to fail" and whether the defence is "bound to be accepted": at para. 49; seeDiscovery Enterprises (C.A.) at para. 11. This Court in Discovery Enterprises (C.A.) approved the description of this requirement as requiring the applicant to show "an arguable case" (para. 10).

36 The onus is on the applicant, not the respondent. The applicant has to not only plead a proper cause of action, but also have some evidence to support the case that its proposed claim has a reasonable prospect of success. This is why the authorities typically review the evidence of the merits of the proposed claim in considerable detail: see for example Discovery Enterprises (S.C.); Primex (S.C.); Arkansas Teacher Retirement System v. Lions Gate Entertainment Corp., 2016 BCSC 432 (B.C. S.C.) [Lions Gate].

37 What the authorities illustrate is that the approach to considering the merits of the proposed action lies somewhere on a spectrum. The court should do more than skim the surface of the pleadings and should consider the evidence but ought not to dive so deeply into the merits as to try the case.

38 Other factors must also be brought to bear on whether the proposed action appears to be in the best interests of the company, namely whether the potential relief sought in the action makes it worthwhile to the company to undertake the costs and inconvenience of pursuing it: Primex (S.C.) at para. 49; Lions Gate at paras. 163 — 165; Jahnke v. Johnson, 2018 SKCA 59 (Sask. C.A.) at para. 68.

In Pasnak v. Chura, 2004 BCCA 221 (CanLII), the Court of Appeal addressed the intersection between the oppression remedy and derivative actions.

In this case, the plaintiff and the defendant conducted business together through four corporations, the shares of which were owned by the individual plaintiff, the individual defendant or holding companies owned by each. The parties wanted to dissolve their business arrangement and had agreed that the plaintiff would buy the defendant's shares in the various companies but were unable to agree to a purchase price. The plaintiff applied to the court under the oppression remedy provisions of the Company Act, R.S.B.C. 1996, c. 62 for an order setting the share price higher than the appraised value on the ground that the defendant had breached his duty to one of the corporations, reducing the value of the shares. The Court of Appeal upheld the decision of Mr. Justice Truscott dismissing the plaintiff's application:

... [Mr. Justice Truscott] ruled that any claim for harm done by Mr. Chura was in relation to his management and control of only one of the companies, Fleetwood Motors Ltd. ("Fleetwood"), and since Mr. Pasnak was a shareholder of Fleetwood and could not show he was affected by the alleged misconduct in a way different from any other shareholder, the claims would have to be pursued by Fleetwood itself through a derivative action: Foss v. Harbottle (1843), 2 Hare 461, 67 E.R. 189 (Eng. V.-C.).

3 On appeal, Mr. Pasnak argues that the trial judge erred in failing to treat the four related companies as one entity for the purposes of winding up and in taking far too narrow an approach to the remedies available in oppression cases. He submits that the trial judge did not respond to the facts of this case and rather than exercise a broad remedial power in equity, he bound himself to prior authorities.

4 According to Mr. Pasnak, the trial judge should have seen that the harm Mr. Chura did to Fleetwood affected the value of the company group as a whole and by analogy to partnership, and therefore he should have applied a remedy by way of the claimed deductions without regard for the separate corporate personalities.

5 For reasons that follow, I can find no error on the part of the trial judge. The authorities are clear that a shareholder must show direct and special harm in order to maintain a personal action for oppression, otherwise he must seek leave to bring a derivative action in the name of the company. Mr. Pasnak's case for deductions depends on ignoring the separate corporate personalities of the four companies. While the remedial jurisdiction in oppression cases is broad, on the facts of this case it cannot wipe out the separateness of the entities. As Mr. Chura's counsel put it, one company cannot be looted to redress the harm done to another.

...

26 It was argued here and below that the court's remedial power was unfettered by such notions as separate corporate personality: Salomon v. Salomon & Co. (1896), [1897] A.C. 22 (U.K. H.L.), and the rule in Foss v. Harbottle, supra, requiring derivative actions. The trial judge rejected, rightly in my respectful view, the argument that s. 200 was intended to brush aside well established company law principles in the quest for a suitable remedy.

27 In my opinion, Mr. Pasnak cannot overcome the obstacle that Fleetwood is a separate entity from the other companies in the group. Consequently, any losses suffered by Fleetwood as a result of Mr. Chura's acts must be redressed within that company. This presents Mr. Pasnak with three difficulties. First, as a practical matter, since Fleetwood's shares have a nil value, then any adjustment in relation to Mr. Chura's shares in Fleetwood can only produce a barren remedy. Second, unless Mr. Pasnak can show that he was affected in a peculiar way, that is, in a manner distinct from the other shareholders by the allegedly oppressive behaviour of Mr. Chura, he must seek leave to commence a derivative action against Mr. Chura in Fleetwood's name. This is said by Mr. Pasnak's counsel to be cumbersome and expensive and not at all in the spirit of s. 200(2) of the Act and s. 10 of the Law and Equity Act, R.S.B.C. 1996, c. 253. Third, the trial judge found that Mr. Pasnak did not demonstrate harm peculiar to him; any losses are those of Fleetwood. This holding obviated the need to make any findings as to oppression, such matters to be left to a derivative action should Mr. Chura choose to pursue that course.

28 I do not accept the proposition that the remedial powers of s. 200(2) can be exercised without reference to established rules. Broad as this discretion may be, it must be exercised judicially, that is, on a principled basis. In S.G. & S. Investments (1972) Ltd. v. Golden Boy Foods Inc. (1991), 56 B.C.L.R. (2d) 273 (B.C. C.A.), this Court held in an oppression case that it was an error to include a shareholder's loan in the purchase price. Madam Justice Southin for the Court reasoned at 281:

. . . A shareholder's loan is a debt owing by the Company to the shareholder. There is nothing in s. 224 [now s. 200] entitling the court to deal with it. Thus, where there is such a debt, the court ought simply to fix the purchase price for the shares and leave the shareholder to whom is owing such a debt his remedy at law for that debt . . . .

...

32 There is only one rule and it was expressed by the Ontario Court of Appeal in Goldex Mines Ltd. v. Revill (1974), 54 D.L.R. (3d) 672 (Ont. C.A.), at 679-80:

It has long been the law that minority shareholders can sue, even where there is a clear wrong to the company, where there has been "an oppressive and unjust exercise of the powers of the majority shareholders for the promotion of an advantage to themselves to the peculiar detriment of the minority": Henderson v. Strang et al. (1919), 60 S.C.R. 201 at p. 202, 54 D.L.R. 674 at p. 675, [1920] 1 W.W.R. 982, followed in Gray v. Yellowknife Gold Mines Ltd. et al. (No. 1), [1947] O.R. 928 at p. 963, [1948] 1 D.L.R. 473 at p. 498.

33 The decision of Madam Justice Newbury (then of the Supreme Court) in Furry Creek Timber Corp. v. Laad Ventures Ltd. (1992), 75 B.C.L.R. (2d) 246 (B.C. S.C.) is consistent with the rule. At 254 she said:

. . . Obviously, the duty of a director to act in the best interests of the company is a duty owed to the company and the company may sue in respect of a breach. Can the same breach be the basis of a shareholder's oppression action? Although there appear to be authorities in Canada that suggest the derivative action and oppression action are mutually exclusive, I think the better view is that it can, provided the complaining shareholder has been affected by the breach in a manner different from or in addition to the indirect effect on the value of all shareholders' shares generally. (See the cases cited in J.G. MacIntosh, "The Oppression Remedy: Personal or Derivative?" (1991), 70 Can. Bar Rev. 29, at pp. 46-52.) . . .

34 The formulation in Goldex Mines, supra, was specifically endorsed by the Supreme Court of Canada in Hercules Management Ltd. v. Ernst & Young, [1997] 2 S.C.R. 165 (S.C.C.), where Mr. Justice LaForest in giving the judgment of the court said at para. 62:

One final point should be made here. Referring to the case of Goldex Mines Ltd. v. Revill (1974), 7 O.R. (2d) 216 (C.A.), the appellants submit that where a shareholder has been directly and individually harmed, that shareholder may have a personal cause of action even though the corporation may also have a separate and distinct cause of action. Nothing in the foregoing paragraphs should be understood to detract from this principle. In finding that claims in respect of losses stemming from an alleged inability to oversee or supervise management are really derivative and not personal in nature, I have found only that shareholders cannot raise individual claims in respect of a wrong done to the corporation. Indeed, this is the limit of the rule in Foss v. Harbottle. Where, however, a separate and distinct claim (say, in tort) can be raised with respect to a wrong done to a shareholder qua individual, a personal action may well lie, assuming that all the requisite elements of a cause of action can be made out.

[Emphasis added.]

35 The trial judge correctly held that Mr. Pasnak and his holding company, Double J., had to meet that requirement in order to sustain a personal, rather than a derivative action. He carefully went through each of the proposed deductions and found that in respect to those to which the rule was relevant, they fell short of the mark.

36 There is one aspect of the case where arguably Mr. Pasnak stands in a different position from other shareholders in Fleetwood and that is in respect of the $175,000 preferred shares. If it had been shown that Mr. Chura's conduct caused a loss in the value of those shares (they are valueless at this point) then it might be successfully argued that Mr. Pasnak met the requirement for direct or special harm. In such case the purchase price may be adjusted along the lines proposed by Mr. Justice Lambert in Oakley v. McDougall (1987), 14 B.C.L.R. (2d) 128 (B.C. C.A.), at 134:

I turn now to the question of valuation. The cases establish that the usual date for valuation in a sale under the oppression remedy is the date of the petition seeking the remedy. The valuation as of that date must make allowance for the future prospects, as seen from that date, and for any negative effect upon the value of the shares on that date caused by the oppression itself: see, generally, the Scottish Co-op. Wholesale Soc. Ltd. v. Meyer, [1959] A.C. 324 at 369, [1958] 3 W.L.R. 404, [1958] 3 All E.R. 66 (H.L.), per Lord Denning, and, in British Columbia, Diligenti v. RWMD Operations Kelowna (1977), 4 B.C.L.R. 134 at 139 (S.C.), and Johnston v. We

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