Appeal Court Confirms Extent of Shareholders’ Right to Sue for Diminution of Share Value

In Canada, there is a well-known corporate law rule, borrowed from an old 1843 U.K. decision called Foss v. Harbottle, that states as follows:

" If a legal wrong is done to a corporation that results in its shareholders losing the value of their shares, those shareholders are not allowed to personally sue the wrongdoer for those losses."

This rule derives from the basic principle that a corporation has a separate legal personality, and that only it has the right to sue others for any wrongs done to the corporation. Shareholders cannot sue on the corporation’s behalf – and conversely they cannot be sued personally for wrongs the corporation

In a recent decision, the Court of Appeal for Ontario offered important clarification on the few potential exceptions to the rule in Foss v. Harbottle.

The facts in Tran v. Bloorston Farms Ltd. involved a woman named Sang who was sole shareholder and owner of a corporation that ran a restaurant called “Gingers”. Importantly, although the corporation operated the restaurant business on the premises, Sang was the only one listed as tenant on the commercial lease. In other words, the restaurant corporation itself was never formally in the role of tenant.

Sang’s landlord had newly purchased the leased property from its former owner. It approached her to demand more rent and a higher share of overall property taxes, alleging that the current amounts she was paying were disproportionately low in light of the physical space that the restaurant was using. When Sang resisted, the landlord precipitously terminated the tenancy, and changed the locks. Gingers restaurant ceased to operate.

Sang sued the landlord directly for damages arising from its breach of the lease. As part of her claim, she asked for damages equivalent to the full former value of her now-worthless shares in the restaurant corporation that operated Gingers.

The Lower Court Decision

Before a motion judge, the landlord was unsuccessful in getting Sang’s claim dismissed as showing no cause of action. To the contrary, the judge granted summary judgment in Sang’s favour, having found the landlord’s demands for additional rent and taxes to be unjustified under the lease terms. The judge declared that the landlord had wrongfully terminated the lease when it locked its tenant Sang out of the premises.

The judge went on to find that Sang’s claim against the landlord for the loss of value of her shares in the restaurant corporation were also valid. The judge expressly found that: 1) the landlord’s wrongful termination of its lease with Sang caused Gingers restaurant to close; 2) Sang’s shares in the restaurant corporation accordingly became worthless; and 3) Sang was entitled to her damages.

In quantifying the amount, the judge ruled that the restaurant corporation was worth only about $3,390, but that the value of the Sang’s shares had been over $140,000 at the point the landlord wrongly terminated the lease. The court awarded Sang these amounts, together with her legal costs of $50,500.00.

The Reasons of the Appeal Court

The landlord appealed, contending that the judge had failed to apply the rule in Foss v. Harbottle to bar Sang’s damages claims against it. The appeal was unsuccessful.

The Court of Appeal confirmed that the rule in Foss v. Harbottle is part of Ontario law, and prevents shareholders – even controlling or sole shareholders like Sang – from personally suing for wrongs done to a corporation. Conversely, the rule operates to affirm the separate legal identity of a corporation, and protects shareholders from being personally sued for a corporation’s misconduct towards third parties.

However, the Appeal Court noted there are a small number of exceptions to the Foss v. Harbottle rule, and observed the historic jurisprudential uncertainty as to their scope and limits. Taking the opportunity to add clarity to the Ontario law, the Court summarized the three legal propositions that address the ability of shareholders to sue for diminution of share value:

  1. Where a corporation suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. A shareholder cannot sue for his or her losses in share value.
  2. Where a corporation suffers loss but has no cause of action itself to sue to recover that loss, in the right circumstances a shareholder may separately sue in respect of it, even though the loss is essentially reflected in the diminution of his or her share values.
  3. Where a corporation suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from the loss suffered by the corporation (e.g. because there has been a breach of a duty independently owed to the shareholder), each may sue to recover for their losses.

In this case, Sang’s claim against the landlord for her losses fell into the second category of permissible exceptions to the Foss v. Harbottle rule. Sang was not attempting to circumvent the rule by pursuing a remedy for a wrong done to the restaurant corporation itself; rather, in the role of tenant she was asserting her own claim for damages arising from the landlord’s breach, in circumstances where the restaurant corporation itself had no tenancy agreement, and thus no cause of action against the landlord.

Sang’s damages therefore included the foreseeable loss in the value of the shares she held, to the extent they were directly caused by the restaurant’s forced closure and subsequent collapse of business. Here, the landlord knew that Gingers restaurant was being operated on the premises, and it could reasonably forsee the cause-and-effect repercussions of wrongfully changing the locks. The Court also noted that the type of loss suffered here – being damage to Sang’s property (i.e. her shares) caused by the premature non-availability of the restaurant premises that she leased – was not outside the type of losses that would naturally and ordinarily be expected to occur from the landlord’s breach of its commercial lease with Sang. The Court dismissed the landlord’s appeal, and confirmed the previous damages awarded granted to her.

The Bottom Line

In Tran v. Bloorston Farms Ltd. the Court of Appeal clearly articulated the three important exceptions to the general rule in Foss v. Harbottle, which otherwise precludes shareholders from suing for a diminution of share value caused by a wrong done directly to a corporation.

Importantly, the Court also expressly settled any uncertainly in the law of Ontario, by examining and endorsing a specific exception for cases where: 1) a shareholder has his or her own cause of action because of a wrong done to him or her, and 2) the corporation – despite suffering its own losses – has no cause of action itself, because no legal wrong was done to it.

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