When a business enters into a contract with another company, it must carry the risk that it will not be able to recoup its losses from the company in the event of its breach. This risk may be magnified when the company is small and closely held. Much of this risk originates in a legal principle dating back over a century that holds that a company must be treated like any other independent person, with its rights and liabilities separate from its owner’s.
When a company breaches a contract, the non-breaching party is generally not permitted to sue its shareholders or directors to access their personal assets. Of course, this can be unsatisfactory to an aggrieved plaintiff. As demonstrated in FNF Enterprises Inc. v. Wag and Train Inc., plaintiffs in such cases have access to a variety of remedies.
Recent Case Considers Remedies Available to Plaintiffs Against the Sole Director and Shareholder of Corporate Tenant
In FNF Enterprises, the plaintiffs were the owners of commercial premises in Kitchener. They leased the premises to the defendant, Wag and Train Inc., for dog grooming, training, and a daycare business. According to the plaintiffs, Wag and Train abandoned the premises, leaving them unsatisfactory and failing to pay any further rent. The plaintiffs also alleged the corporate defendant moved its business elsewhere in Kitchener and set it up under a different name.
Wag and Train’s sole director, officer and shareholder were also named personally as defendants. The plaintiffs alleged, among other things, that her conduct justified piercing the corporate veil so that she was personally responsible for Wag and Train’s liabilities. The plaintiffs also claimed her conduct entitled them to relief under the oppression remedy in section 248 of the Business Corporations Act. Specifically, they argued that despite being aware that Wag and Train had liabilities under the lease, she “stripped value” from the company and caused the business to be moved elsewhere.
The motion judge found that the lawsuit did not disclose “a reasonable cause of action” against the individual defendant and should be struck out against her. The plaintiffs appealed. The Ontario Court of Appeal reviewed the law applicable to piercing the corporate veil and the oppression remedy. We have previously written about these two areas of the law, but a brief review here will be helpful.
The Test for Piercing the Corporate Veil
Courts generally apply a two-part test in deciding whether or not to pierce the corporate veil and make individuals personally responsible for the liabilities of a company. First, as set out in the leading case of Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co., there must be evidence of ownership or control of the corporation but “complete domination or abuse of the corporate form.” Second, there must have been fraudulent or improper conduct that gave rise to the liabilities in issue. This may be the case where a company is incorporated “for an illegal, fraudulent or improper purpose” or “those in control expressly direct a wrongful thing to be done.”
Wrongful Conduct of Director/Shareholder Must Give Rise to the Liabilities In Issue
As the Court noted, the object of the plaintiffs’ claim in FNF Enterprises was to hold the individual defendant liable for the obligations of Wag and Train in relation to the lease. However, to do this by piercing the corporate veil, the “wrongful conduct” alleged by the individual defendant must have given rise to those obligations.
The plaintiffs alleged that the individual defendant’s liability was justified in two ways. First, they argued that she had decided to breach the lease as the sole director of Wag and Tail. Second, they argued that she had “stripped value” from the company, knowing its lease obligations. Ultimately, the Court dismissed this aspect of the appeal.
Directors Generally Not Liable for Inducing A Company to Breach a Contract
With respect to the first argument, the Court noted that the law does not generally hold a director personally liable for causing a company to breach a contract. This principle is well-established in the common law, except where the director has acted in bad faith or outside of the scope of their authority. Accordingly, the Court concluded lifting the corporate veil to make the individual defendant liable for Wag and Tail’s breach of contract would violate this principle.
“Value Stripping” Is Unrelated to Breach of Lease Liabilities
Regarding the second argument, the plaintiffs alleged the defendant’s conduct had been wrongful when she stripped value from Wag and Tail while being aware of the company’s lease liabilities. Yet, the Court noted it was the lease liabilities themselves that the plaintiffs sought to impose on the individual defendant. Therefore, there was no connection between the alleged wrongful conduct and the liabilities imposed on the individual defendant if the corporate veil was pierced. While the value stripping might ultimately prejudice the plaintiffs “in their ability to collect,” this was insufficient. Accordingly, the remedy sought by the plaintiffs of piercing the corporate veil had no reasonable chance of success, and the plaintiffs’ claim in this regard was struck.
The Court then considered the second aspect of the appeal, namely the plaintiffs’ claim for an oppression remedy.
The Test for An Oppression Remedy
Under section 248 of the Business Corporations Act, an oppression remedy may be granted where a complainant establishes that certain corporate conduct has violated their reasonably held expectations and that conduct was “oppressive or unfairly prejudicial to or unfairly disregarded” their interests. Further, the law has held that a director may be personally liable for such oppressive conduct if two requirements are met. As the Court in FNF Enterprises explained, relying on Supreme Court of Canada precedent, it must first be established that the director had “the requisite degree of involvement in the oppressive conduct so that it is attributable to them”. Second, it must be established that the director’s personal liability is “fit” in the circumstances. The Court went on to state that personal liability will be fit “where it is a fair way of dealing with the situation, the order goes no further than necessary to rectify the oppression, the order serves only to vindicate the reasonable expectations of the complainant, and other forms of statutory and common law relief are not more fitting in the circumstances.”
Allegation of “Value Stripping” Presents an Arguable Case Potentially Justifying an Oppression Remedy
The Court of Appeal referred to the conclusion drawn by the motion judge that the oppression remedy was not to be used to make a director a “personal guarantor” of a company’s obligations. However, the Court drew a distinction between a creditor who assumed a particular risk when entering into a contract with a company and a creditor who subsequently faces such a risk due to “unlawful and internal corporate maneuvers” in relation to that company. The Court noted that if the defendant had engaged in value stripping, such conduct might constitute an “unlawful and internal corporate maneuver” warranting an oppression remedy. In this regard, the Court noted that value stripping might contradict various statutory prohibitions set out in the Business Corporations Act. The Court specifically referenced the prohibition against a director declaring a dividend to a shareholder when the company could not pay its creditors (section 38(3)) and the prohibition against a shareholder having a right to the company’s assets. At the same time, it is ongoing, a right which only arises on the company’s wind-up and which is subject to the rights of unpaid creditors (section 221(1)(a)). Such steps might constitute a misuse of corporate power that satisfies the test for personal liability being imposed upon the individual defendant. For this reason, this aspect of the appeal was allowed.
In light of the Court’s reasoning in FNF Enterprises, creditors would be wise to consider seeking an oppression remedy against the directors of a potentially impecunious corporate defendant if there are any indications of “unlawful and internal corporate maneuvers” in relation to that company.
Contact the Litigation Lawyers at Milosevic & Associates in Toronto for Legal Representation In Debt Collection and Contract Disputes
The litigation lawyers at Milosevic & Associates are available to provide effective and strategic advice in lease and other contract disputes, debt collection enforcement, and corporate oppression claims. We aim to resolve our client’s business issues practically and efficiently. Contact us online or by phone at (416) 916-1387 for a consultation.