Shareholder Remedies: Appointment of Inspectors

As an incident of their investment in a corporation, shareholders are afforded certain rights and remedies, most of which are established under the Ontario Business Corporations Act (“OBCA”) or the Canada Business Corporations Act (“CBCA”). Key among these is the oppression remedy, which can be invoked if shareholders can show that the corporate business or the conduct of a director has been exercised in a manner that is oppressive, unfairly prejudicial to, or unfairly disregards their interests.

In the right circumstances, shareholders can wield a powerful tool in their arsenal of oppression-related remedies: The ability to ask a court to appoint an inspector to conduct an inspection into the corporation’s business and financial affairs. This remedy is found in s. 161(2) of the OBCA (or its equivalent in the CBCA), and can be exercised by the court on a discretionary basis if it is satisfied that certain legislated pre-conditions are in place, including an initial finding that there is oppression or fraud.

A recent Ontario decision elaborates on the test for obtaining such an order. The ruling suggests that an inspector may be appointed where there is an “index of suspicion”, which can exist in scenarios where the company fails to discharge its statutory obligation to make financial disclosure.

The Background Facts in Millership v. HyperBlock Inc

In Millership v. HyperBlock Inc. 2019 ONSC 2903, the disgruntled shareholders held shares in a newly-amalgamated company called HyperBlock, the centerpiece of which was an existing cryptocurrency mining facility called “Project Spokane”. Although the goal of amalgamation was to position HyperBlock and Project Spokane to become leaders in the North American market, the results in the first quarter after the amalgamation were vastly disappointing. Within mere weeks of the closing, HyperBlock experienced a significant decline in share value.

The shareholders pointed to a set of large, questionable write-offs by HyperBlock, and the contentious manner in which certain allegedly over-valued assets (to the tune of US$65 million) had been dealt with. There were also suspicious irregularities in the details leading up to the amalgamation, including representations and revenue forecasts that were now dubious.

The court summarized the overall chaos of the situation this way:

“…. [W]ithin one quarter of the July 2018 closing, there has been a collapse in every one of Project Spokane’s major revenue streams, a flurry of new and unexplained payables purportedly owing to Project Spokane, a significant write-down of approximately US$21.5 million in goodwill … a delay in what was presented as a fully-funded expansion of the Montana [Project Spokane] facility, irregularities in the number of servers, and a discernible lack of initiative on the part of Mr. Walsh and the current board of directors to provide information to justify the situation.”

The shareholders’ own investigative efforts revealed a significant decline in HyperBlock revenues and a different financial picture than had been presented originally. For example, the pre-amalgamation projections had initially shown the company to be capable of generating US$20 million annually, whereas the true figures appeared to be closer to $3 million.

The shareholders asked the court to appoint an independent, arm’s length inspector to conduct an investigation under s. 161(2) of the OBCA.

After reviewing the facts, the court agreed that there was evidence of oppression to satisfy the initial prerequisite in s. 161(2). The next question was whether it should exercise its discretion to appoint an inspector and order an investigation. The court noted the threshold for doing so was low.

The Test for Appointing an Inspector – An “Index of Suspicion”

One of the core obligations of a corporation toward its shareholders is to provide audited financial statements: Packall Packaging Inc. v. Ciszewski, 2016 ONCA 6. In the right circumstances, a corporation’s failure to meet this obligation can form that “index of suspicion” that supports an order to appoint an investigator: Jones v. Mizzi, 2016 ONSC 4907. Without an investigation, the facts that were otherwise inaccessible to the shareholders would not be brought to light.

The test was illustrated in some of the prior court decisions in which the governing test was considered. For example, in an early case called Royal Trustco Ltd., Re 1981 CarswellOnt 120, the court concluded it was entitled to make the investigation order if it had “good reason to think the conduct complained of may have taken place.” In a decision called Catalyst Fund General Partner I Inc. v. Hollinger (2004), 2004 CanLII 66299, the requirement was satisfied where – when viewing the actions or non-actions of management and directors – there is “at the very least an index of suspicion or appearance that reasonable shareholder expectations have not been met”. The inspection was viewed as being an appropriate means for testing whether further court-ordered relief is warranted.

A more recent decision called Jones v. Mizzi 2016 ONSC 4907 puts he test more simply: A court order to appoint an investigator can be made where there is simply an “index of suspicion”.

The Court in Millership v. HyperBlock Inc. ultimately held that the shareholders’ reasonable expectations were not being met and there was an index of suspicions warranting an inspector be appointed to investigate the company.

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