Court-Appointed Inspectors in Shareholder Disputes: The Threshold Test, Illustrated

In cases involving an application by shareholders for the oppression remedy under either the Canada Business Corporations Act R.S.C., 1985, c. C-44 (CBCA) or the Ontario Business Corporations Act R.S.O. 1990, c. B.16 (OBCA), courts have the authority in appropriate cases to order an investigation into the corporation’s affairs. This allows relevant facts to be uncovered, and assists in exploring whether further relief in the form of a court-ordered oppression remedy might be warranted.

Commonly, these kinds of orders are sought by shareholders when the corporation shows deficiencies in its structure or protocols – for example where it fails to install an approval process to oversee directors’ activities, or otherwise fails to ensure they are acting in the corporate best interest at all times.

This power to order an investigation adds what the courts have called a “moral or ethical element” to the task of evaluating officers’ and directors’ conduct against the background of the shareholders’ legitimate expectations: Consolidated Enfield Corp. v. Blair, [1994] O.J. No. 850 at para. 79, as cited by Catalyst Fund General Partner I Inc v. Hollinger Inc., [2004] O.J. No. 3886, 48 B.L.R. (3d) 194 at para. 55.

The Source of the Courts’ Authority to Order an Investigation

For federal corporations, this remedy is found in s. 229 of the CBCA, which allows the court to order an investigation of the corporation and any of its affiliates. The provincial counterpart is found in s. 161 of the OBCA.

To warrant making the order, the court must find in a general sense that – when viewing the actions or non-actions of management or directors – there is at least some indication of suspicion or the appearance that reasonable shareholder expectations have not been met. A prima facie case can therefore be tested with an inspection, to determine whether further court-ordered relief is warranted.

More specifically, the legislation mandates that the court must be satisfied of at least one of several grounds, including: a) that the business of the corporation has been carried out with the intent to defraud any person; or b) that the powers of the directors have been exercised in an oppressive or unfairly prejudicial manner as they relate to the interests of a security holder.

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Once the order has been made, its terms typically allow for the investigator to make a broad inquiry into the corporation’s business affairs.

An Illustrative Case Background

A case that illustrates this investigative remedy, and the court’s threshold for imposing it, is called Catalyst Fund General Partner I Inc. v. Hollinger Inc.: 2004 CarswellOnt 3782, [2004] O.J. No. 3886, 48 B.L.R. (3d) 194.

There, the shareholders’ prime concern was the corporation’s apparent lack of oversight around the monitoring and approval of “related-party” transactions, several of which had been recently completed without proper disclosure to stakeholders. The transactions had also come under scrutiny because they appeared to financially benefit eight of the current directors on the Board, putting them in a potential conflict.

In response to these concerns, the corporation formed a special audit committee, and directed it to conduct an investigation and report its findings to the Board. The committee did so, and ultimately recommended that the eight directors should voluntarily resign, or else be terminated by the corporation.

Perhaps not surprisingly, those eight directors voted to reject the recommendation; in doing so, they formed the majority vote on the 12-member Board. The four remaining independent directors, who had voted to approve the audit committee’s recommendations, all promptly resigned, as did the corporation’s own auditor. The audit committee’s findings were never implemented by the corporation, which also sparked litigation by third parties.

At that point, the corporation acknowledged the need for an independent investigation of its financial affairs. It hired independent auditors and promised to undergo a full audit of its accounts and transactions, including the questionable related-party transactions. However, 10 months passed without any new information being provided to shareholders. During this time, the eight impugned directors continued in their management roles, unimpeded.

One of the substantial shareholders then applied to the court for an order under the CBCA for an investigation of the corporation. The focus was to be the payments made to the directors and their related corporations, including whether those payments had been properly authorized, and whether any conflict of interest had been disclosed.

Disclaimer: The content in this article is provided for general information purposes only. It does not constitute legal advice. All rights are reserved.