In Groupe d’action d’investisseurs dans Biosyntech v. Tsang, 2016 QCCA1923, the Quebec Court of Appeal has re-affirmed that a shareholder has no
direct cause of action against a director for loss of share value flowing from
harm done to the company.
While the result is hardly
ground-breaking – it simply reflects the 19th century Foss v. Harbottle rule, well-known in
common law jurisdictions – the Court of Appeal justifies its conclusion on the
civilian premise that the only damages that are actionable are those that are
the “immediate and direct consequence” of a wrongful act.
This ruling also demonstrates
the extent to which an authorization to institute class proceedings can be
denied “based purely on a meticulous analysis of the legal argument
under-pinning the factual allegations”.
Context
The shareholders of BioSyntech
Inc. had lost the value of their shares when the company went bankrupt. A group
of shareholders blamed the company’s bankruptcy on the company’s former
directors, who had allegedly:
(1) Failed to disclose
results of a pivotal clinical trial;
(2) Failed to reduce the
excessive rate at which BioSyntech’s cash was being depleted;
(3) Failed to diligently
pursue opportunities to obtain additional financing; and had
(4) Filed a notice of
intention under the Bankruptcy and
Insolvency Act (“B.I.A.”),
sending BioSyntech into an avoidable bankruptcy.
In bankruptcy proceedings
before the Superior Court, the shareholders had admitted that the damages they claimed
were indirect. The directors’ alleged wrongdoing only caused direct damage to
BioSyntech, “and this damage, in turn, caused the loss of share value claimed
by the shareholders”.
Justice Hamilton denied
authorization at first instance. He recognized an “ongoing debate” as to
whether shareholders might possess a direct cause of action against directors
for a breach of their duty of care under section 122 b) of the Canada Business Corporations Act.
However, in light of the indirect nature of the damages claimed, the first
instance judge was of the view that the shareholders had failed to demonstrate
that the alleged facts seem to justify the conclusions sought.
No
recovery for “indirect” damage
The appeal was dismissed. In
Schrager J.A.’s view, the shareholders’ claim must flounder because article
1607 of the Civil Code of Quebec “only
permits recovery of damage which is the direct consequence of a harmful act”.
Indirect damage, in his words, is
not the injury “caused by the act of the wrongdoer, but rather is caused by the
damage which the wrongdoer caused”. In
this case, the loss of share value was indirect, since:
[23] […] the damages
[…] were not caused directly by the directors alleged breach of their duty of
care by not obtaining, for example, adequate financing for BioSyntech. That
alleged fault might (arguably) have caused (in whole or in part) the insolvency
and inability of BioSyntech to pursue its business. It is the insolvency which
caused the shares to lose their value so that such damage would be caused
indirectly to the shareholders by the directors.
This civilian argument – relying
as it does on article 1607 of the Civil
Code of Quebec – essentially replicates the Foss v. Harbottle rule well-known in common law jurisdictions. As
such, “individual shareholders have no cause of action in law for any wrongs
done to the corporation and that if an action is to be brought in respect of
such losses, it must be brought either by the corporation itself (through
management) or by way of a derivative action”.
This rule is a “consequence of
the fact that a corporation is a separate legal entity”. Moreover,
as a matter of policy, in the absence of Foss
v. Harbottle:
[25] […]
shareholders could potentially sue where a company would also have a right of
action against the same wrongdoer who would become liable to compensate both
the shareholders and the company for their losses. If only the company sues
then all its stakeholders benefit; the proceeds of the lawsuit are notionally
used by the company to pay the creditors and any surplus enhances shareholder
value. Without the rule, which is the scenario put forward by Appellants, the
shareholders would jump the queue or the order of priority under the B.I.A. and be paid before creditors for
prejudice suffered by the company.
The Court of Appeal added that
there was “really nothing” in either of the Supreme Court of Canada’s leading
decisions in Peoples Department Stores
Inc. (Trustee of) v. Wise and BCE
Inc. v. 1976 Debentureholders that suggests “that a breach of the duty of
care entitles shareholders to recover compensation from directors for indirect
injury”.
Schrager J.A. nevertheless recognized
that, in some circumstances, the loss of share value can be a direct injury,
independent from damage suffered by the company.
In Houle v. Banque Canadienne Nationale, for instance, shareholders
“successfully sued the company’s banker for damage caused by the bank which
abruptly and negligently called for repayment of the company’s borrowings”,
thereby harming the shareholders who were then in the process of selling their
shares. The damage suffered by a shareholder would also be direct and
independent in the case where a shareholder:
[31] […] purchases
his shares based on the negligent or fraudulent misrepresentation of directors.
Such a scenario causes the shareholder to have parted with his money and buy
worthless shares and thus, suffers harm independent from the company giving
rise to a good cause of action against directors for damages directly suffered
by the shareholder.
In this case, the alleged
damage was indirect and therefore not actionable.
The Court of Appeal chose not
to wade too heavily into the “ongoing debate” over whether the Supreme Court of
Canada’s leading decisions in Peoples and
BCE contemplate a direct cause of
action for shareholders against directors and officers for a breach of their
duty of care. On this point, Schrager
J.A. limited himself to saying that the “facts of the matters before the
Supreme Court did not strictly require consideration of whether shareholders
are included in “stakeholders” to whom directors owed their duty of care under
Section 122 b) C.B.C.A.”.
Alternative
recourse?
Finally, Schrager J.A. turned
to the question of what other recourses may have been open to the shareholders,
faced as they were with the bankruptcy trustee’s refusal to institute
proceedings against the directors on behalf of the company.
He chose not to opine on the
question of whether the shareholders could have sought an order against the
trustee to “reverse or modify the act or decision complained of”, pursuant to
section 37 of the B.I.A. He also declined to decide whether, pursuant
to section 38 of the B.I.A., the
shareholders could have obtained an order authorizing them to exercise the
company’s rights of action. Lastly, while an action in oppression against the
directors pursuant to section 241 C.B.C.A.
was theoretically possible, courts have split on the question of whether or
not an action in oppression could be authorized as a class action. The former,
after all, “is already representative in nature in that it provides a potential
remedy not only to the petitioner but to all shareholders of a class who suffer
from the oppressive conduct”.
Unfortunately for the rest of
us, these legal questions were not deserving of the same “meticulous analysis”
at the authorization stage!
As is required by article 1003, sub-paragraph b) of the former (and governing) Code of Civil Procedure, a condition
which remains unchanged in the corresponding article 575(2) of the new Code of Civil Procedure.
