Derivative Actions under the OBCA - Illustrated

Most Canadian businesses are run using a corporate structure; this is common knowledge. But what is less well-understood is that the concept of a �corporation� is premised on a legal fiction: Even though it does not exist in the physical world, a �corporation� has legal status as a stand-alone entity, and operates through the day-to-day business-related efforts of its directors and officers.

The corollary to this concept is that when it comes time for a corporation to assert a legal action to protect itself, seek a remedy, or pursue its rights, those steps must be taken by another party standing in the place of the corporation.

How is this accomplished, in law? The answer comes in the form of a �derivative action� which is available to certain qualifying individuals as an avenue of recourse under section 246 of the Ontario Business Corporations Act (the �OBCA�) or section 239 of the Canada Business Corporations Act (the �CBCA�) Specifically, anyone who satisfies the definition of �complainant� may apply to the court for leave (i.e. permission) to bring an action in the name of, and on behalf of the corporation.1 For these purposes, a �complainant� is defined to include a director or officer, as well a registered shareholder.

To obtain leave, an eligible complainant must satisfy the court that:

1) He or she is acting in good faith;

2) The directors themselves will not bring, diligently prosecute/defend, or else discontinue the action (as the case may be); and

3) The action appears to be in the interests of the corporation or its subsidiary. 2

If the court finds it appropriate to grant leave under s. 246, it can make �any order it thinks fit�; this includes allowing the complainant to go forward with the litigation, and directing the corporation itself to pay the reasonable legal fees needed by the complainant to do so.

Case Example: Competing Derivative Actions

The recent Ontario decision in Agisheva v. Petrov3 started with what the court called �[t]wo enterprising couples [who] decided to go into business together,� but ended with a unique scenario involving two competing pairs of shareholder/directors, each of whom asked the court to grant them leave to bring separate derivative action against the other, on behalf of the corporation.

Dimitri and Natali (Couple A) and Andrii and Saniia (Couple B) had immigrated to Canada from Russia and Ukraine, respectively. As part of their joint venture involving polymer coating originating from Ukraine, they created a corporation named Sunbex. Each of the four held 25 percent of Sunbex�s shares, and served as both a director and officer.

The primary role of Couple A was to source the polymer coating, and to secure polymer-application contracts with third parties in Canada. Couple B was mainly in charge of arranging for a specialized team of labourers from Ukraine. Couple A also brought Sunbex its first large contract from a third party, to apply the polymer to oil tanks in Newfoundland; pursuant to a shareholders� agreement the significant profits arising under that contract were split evenly between both Couples.

However, in 2017 the business relationship became strained for various reasons, among them the fact that the owner of the Newfoundland oil tanks complained that the polymer coating was inferior, and demanded that Sunbex repair the work already done. Shortly after, Couple A surreptitiously formed a new corporation that provided consulting services to a competing company called �Midstream�, which proceeded to contract with the same Newfoundland tank owner to provide the same services that Sunbex had been providing, using the same Ukrainian crew.

Upon realizing this development, Couple B naturally took issue with Couple A�s conduct, accusing them of misappropriating corporate opportunities by diverting business from Sunbex to themselves, through Midstream.

In response, Couple A accused Couple B of misdeeds as well, which included misappropriating corporate funds and claiming expenses improperly. They also claimed Couple B was sabotaging Sunbex�s business by delivering defective polymer coating, causing a loss of credibility with the Newfoundland customer and exposing Sunbex to warranty claims. According to Couple A, this cost Sunbex about $240,000 in unneeded and unforeseen costs.

The Test for Granting Leave

Against this background � and each having respective status as 50 percent shareholders of Sunbex � both Couple A and Couple B asked the court for the same remedy: Permission to bring a derivative action on behalf of Sunbex, each for different legal claims against the others in their roles as directors of the company.

Respecting the three-part test to be applied, the court noted that �[t]he bar is relatively low,� and included only a requirement that the proposed action �appears� to be in Sunbex�s interests. The court added that the governing test was to be given a liberal interpretation in favour of the complainant.

Ruling on Leave Applications

The court considered the merits of the tandem applications under s. 246 of the OBCA. It concluded that Couple B had indeed satisfied the test for granting leave. Specifically they:

1) Were �complainants� under the OBCA, since they were directors, officers and shareholders;

2) Had a valid cause of action for wrongful misappropriation of its polymer coating business; and

3) Intended � without ulterior motive � to launch that action in good faith on behalf of Sunbex, to benefit all shareholders.

Also, in these circumstances Couple A could never be counted on in their roles as directors to essentially prosecute a claim against themselves. As the court explained:

If it can be proven that corporate opportunities were diverted from Sunbex to Midstream, any damages awarded to Sunbex would benefit all the shareholders.

The proposed derivative action [by Couple B] appears to be in the best interest of Sunbex. The action is aimed at recovering substantial revenues allegedly owed to Sunbex under the [Newfoundland] contract and other potential business opportunities that would have been available to Sunbex had they not been diverted by the [Couple A] shareholders in breach of their fiduciary duties.

In contrast, the competing application by Couple A for leave to bring their own derivative action met only some of the required tests, but not all of them. In particular, Couple A was not acting in good faith because their claims on behalf of Sunbex were not well-founded. The court found that several of their allegations were based on questionable assertions � and indeed on some factually non-existent situations. In short, they did not show an arguable case on the merits.

Ultimately, the court granted Couple B the permission to commence and prosecute a derivative action on behalf of Sunbex, against Couple A in their role as directors, but dismissed the application by Couple A to bring a converse action in their own right. Disclaimer: The content in this article is provided for general information purposes only. It does not constitute legal advice. All rights are reserved.

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