Auditing the Audit Requirement - Bennett Jones

April 2010Auditing the Audit RequirementNumber 188By: Bryan Haynes. © Bryan Haynes. Reproduced with permission.This article first appeared in the March 2010 issue of CANADIAN LawyerMagazine.InsideMost jurisdictions in Canada require the unanimous consent of allshareholders, including non-voting shareholders, in order for anon-distributing corporation to dispense with an audit. The requirement Legislative Updateis absolute and mandatory — there are no other exemptions or qualifica- Federal ................. 2tions. The public policy rationale behind the rule is laudable; however,Alberta................. 3the implementation in practice can be austere. It is time to revisit theuniversal audit requirement as it applies to non-distributing corporations.British Columbia ....... 3The Canada Business Corporations Act, and its provincial counter-Recent Casesparts, generally provide that shareholders of non-distributing corpora- Right of Shareholderstions may resolve not to appoint an auditor provided that such resolutionTo Receive FinancialStatements ofis consented to by all shareholders, including shareholders not otherwiseSubsidiaryentitled to vote. Corporations........... 3Liability of Directors forAlthough the Prince Edward Island Companies Act is silent on thisUnremitted Sourcepoint, it does stipulate that the directors of every company shall lay Deductions ............ 4before the shareholders a full and clear statement of the affairs andLiability of Director forfinancial position of the company at or before each annual general Unremitted Sourcemeeting. In MacLeod and John L. MacLeod Transport, Consultant and Deductions ............ 5Management Ltd. v. Murray and Murray, it was held that this requirement Unanimouscould only be satisfied by producing audited financial statements. In Shareholders’striking contrast to every other jurisdiction in Canada, New Brunswick Agreement andpermits, but does not mandate, the appointment of an auditor. Moreover,Arbitration ............. 6if an auditor is appointed in any given year, such appointment Employee Shareholdermay be dispensed within the ensuing year by ordinary resolution (thus Entitled tonot requiring unanimity).Compensation WhereAttempts To PurchaseShares for CancellationThe underlying public policy rationale of the universal audit require-Invalid.................. 7ment is clear — investor protection, and in particular, the protection ofLiability of Director forminority shareholders. It has been held that shareholders (voting andUremitted Taxnon-voting) have a right to be informed, and have an independent Amounts ............... 8assessment, of a company’s financial position in order to inter alia enableshareholders to assess their investments (and management) on a contin- Continuing Legaluing and consistent basis. The jurisprudence has routinely Education Opportunity 91

Corporate Brief 2confirmed and upheld the sanctity of this right (includingMerrill v. Afab Security, Chrisger Systems Inc.; LabattBrewing Co. v. Trilon Holdings Inc.; Smith v. ECO GroutingSpecialists Ltd.; Runnalls v. Regent Holdings Ltd.; Barbour v.Jamestown Lumber Co.). In Discovery Enterprises Inc. v.ISE Research Ltd., it was noted: ‘‘The refusal of a companyto deliver audited financial statements can serve to hidethe true financial position from a minority shareholder.’’However, universal application of this onerous requirementcan have unintended and severe consequences, par-ticularly on small, privately held corporations. Often, anaudit is unnecessary or prohibitively expensive and dispro-portionate to the financial resources of the company andthe value of a shareholder’s investment. Audits can costtens of thousands of dollars and paying the cost of an auditcan leave a company with reduced or no profits to distributeto shareholders, or worse yet, further indebted.Ironically, the very application of the principle that isintended to protect shareholders’ investments could in factjeopardize them.Since dispensing with an auditor requires unanimousconsent, the fate of a company, and every other shareholder’sinvestment (and return on same) in that company,could rest in the hands of a single shareholder regardless ofsuch shareholder’s status as a voting or non-voting share-holder and regardless of the size of such shareholder’sCORPORATE BRIEFCanada’s ironclad audit requirement is ill-suited,imbalanced, and disproportionate for countless small, pri-vate companies. A better balance between the rights ofminority and majority shareholders is called for.Published monthly as the newsletter complement to the CANADACORPORATIONS LAW REPORTER, the ALBERTA CORPORATIONS LAW GUIDE,the BRITISH COLUMBIA CORPORATIONS LAW GUIDE, the CANADIANCORPORATE SECRETARY’S GUIDE and the ONTARIO CORPORATIONS LAWGUIDE, by CCH Canadian Limited. For subscription information,see your CCH Account Manager or call 1-800-268-4522 or (416)224-2248 (Toronto).For CCH Canadian Limited:CASSANDRA WATSON, B.A., LL.B., Writer(416) 224-2224, ext. 6357e-mail: cassandra.watson@wolterskluwer.cominvestment. As much as it may be unfair to a minorityshareholder to deny an independent assessment of a company’sfinancial statement, it is equally, perhaps more,unfair to the remaining majority shareholders to endurethe consequences of such an assessment if otherwiseunnecessary or uneconomical.The case law has held that a shareholder’s motive in,and the financial consequences of, requiring an audit areirrelevant. Struck with the unwavering harshness of this rule,some judges have rightly tried to alleviate its ramifications.In Barbour, Justice Handrigan wrote: ‘‘I took this limitationinto account by restricting the audit to JamestownLumber’s most recent fiscal period. It would, in the circumstanceshere, be an unfair and unnecessary expense to thecorporation and ultimately for its other shareholders tobear to require an audit for any longer period.’’When compared with other leading corporate lawjurisdictions, Canada’s model of universality is draconian.Some American states (including New York and Delaware)do not require audited financial statements of private com-panies. In both the United Kingdom and Australia, statutoryexemptions from audit requirements, based on revenues,assets, and number of employees, are provided to smallprivate companies. However, notwithstanding that a com-pany may otherwise qualify for exemption from auditrequirements, members (voting and non) of U.K. companiesrepresenting at least 10 per cent of the nominal valueof a company’s share capital, and voting shareholders ofAustralian companies holding at least five per cent of thevotes, may demand an audit.Bryan Haynes (haynesb@bennettjones.com) is apartner and co-chairman of the commercial transactionspractice group at Bennett Jones LLP.ADEELA AHMAD, B.A., Editor(416) 224-2224, ext. 6262LEGISLATIVE UPDATEe-mail: adeela.ahmad@wolterskluwer.comIVER CHONG, B.A., B.Ed., Associate Editor(416) 224-2224, ext. 6278e-mail: Iver.Chong@wolterskluwer.comNATALIE MEDITSKY, B.A.A, Editor(416) 224-2224, ext. 6246Federale-mail: natalie.meditsky@wolterskluwer.comSOR/2010-72, Regulations Amending Certain Depart-SHIRLEY SPALDING, B.A., Associate Editor(416) 224-2224, ext. 6211ment of Industry Regulations, came into force on March 25,e-mail: Shirley.Spalding@wolterskluwer.com 2010.The changes affect Part 2 of the regulations under theCanada Business Corporations Act and Part 2 of the regu-lations under the Canada Cooperatives Act which bothdeal with name granting requirements. The objective of thechanges is to clarify the rules regarding the names of corporationsand cooperatives. Other than a new sectionallowing more flexibility in naming a corporation or cooperativeresulting from a short-form amalgamation, the pro-CHERYL FINCH, B.A., LL.B., Director of EditorialLegal and Business Markets(416) 228-6128e-mail: Cheryl.Finch@wolterskluwer.com© 2010, CCH Canadian Limited90 Sheppard Ave. East, Suite 300Toronto, Ontario M2N 6X1Tel: (416) 224-2224Fax: (416) 224-0729

3Corporate Briefposed changes do not make substantive changes to the Financial Institutions Act, sections 215.1 and 215.2, whichname granting regulations. Instead, the regulations have deal with extrajurisdictional evidence, and section 219.1,been revised to be clearer and easier to read and to which deals with the collection and sharing of informationaddress concerns raised by the Standing Joint Committee regarding financial institutions.on the Scrutiny of Regulations regarding the wording of theregulations.Sections 4, 5, 9, 10, 12 to 14, 15(b), 20, 25, 26(b), 28(b),34 to 37, and 43 to 50 have not yet been proclaimed.These regulatory changes will be incorporated into the Section 14 the Act will add a new division to Part 4 of theCANADA CORPORATIONS LAW REPORTER.Financial Institutions Act. Division 2.1, ‘‘Actuaries — InsuranceCompanies’’, contains new sections 126.1 to 126.31.Jobs and Economic Growth Act, Bill C-9 received first Section 45 of the Act will add, to the Personal Propertyreading on March 29, 2010. Bill C-9 affects various Acts, Security Act, sections 7.2 to 7.6, which deal with transition.including:These statutory changes will be incorporated into the● The Financial Consumer Agency of Canada Act which is BRITISH COLUMBIA CORPORATIONS LAW GUIDE.amended to provide the Financial Consumer Agency ofCanada with a broader oversight role to allow it to verifycompliance with ministerial undertakings and directions.The amendments also increase the Agency’s ability toRECENT CASESundertake research, including research on trends andemerging consumer protection issues;● ● ● Nova Scotia Court of Appeal ● ● ●Minas BasinHoldings Ltd. (‘‘Minas Basin’’) was a private company, 99%of the shares of which were held by a single majority shareholder,while less than 1% of shares were held by minorityshareholders. The majority shareholder had attempted topurchase the holdings of the minority under a Plan ofArrangement, but dissent by some of the minority meantthat an independent valuation of the shares would havebeen required and the company abandoned the plan. Therespondent, who was one of the minority shareholders,requested that the company permit him to examine thefinancial statements of Minas Basin’s various subsidiarycompanies. By way of response, Minas Basin filed an applicationseeking an order under the Companies Act (the‘‘Act’’) barring the right of the applicant shareholder fromexamining the financial statements in question (seeONTARIO CORPORATIONS LAW GUIDE 51,504, CANADA CORPORA-TIONS LAW REPORTER 200,848, ALBERTA CORPORATIONS LAW GUIDE79,267, CANADIAN CORPORATE SECRETARY’S GUIDE 51,128, andBritish Columbia Law Guide 78,691). The application wasdismissed, the Court holding that the company had notmet the onus of showing that detriment would result fromproviding shareholders with access otherwise permitted bystatute. The Court held that there was no suggestion thatthe shareholder request for information was connectedwith any illegal or improper purpose, and that the assessmentof corporate financial documents was a legitimateshareholder exercise. In light of the company’s concerns,the Court’s decision included an order binding the shareholderto share information provided only with hisaccountant and/or his solicitor. The company appealedfrom the decision of applications judge.● The Proceeds of Crime (Money Laundering) and TerroristFinancing Act which is amended to confer on theMinister of Finance the power to issue directivesimposing measures with respect to certain financialtransactions. The amendments also confer on the Gov-ernor in Council the power to make regulations that limitor prohibit certain financial transactions; and●The Bank Act and other related statutes which areamended to provide a framework to enable creditunions to incorporate and continue as banks. The modelis based on the framework applicable to other federallyregulated financial institutions, adjusted to give effect tocooperative principles and governance.AlbertaBill 13, the Securities Amendment Act, 2010, receivedfirst reading on March 18, 2010 and second reading onMarch 25, 2010. Bill 13 proposes amendments to theSecurities Act and to the Securities Amendment Act, 2006.These statutory changes will be incorporated into theALBERTA CORPORATIONS LAW GUIDE.British ColumbiaThe appeal was dismissed. The company based itsappeal on three grounds. First, it alleged that the applica-tions judge had erred by adopting a narrow and strict viewof the meaning of ‘‘detriment’’, by requiring the companyto establish ‘‘undue’’ detriment, and by failing to engage ina balancing of the detriment to the company, financial andS.B.C. 2010, c. 4, formerly Bill 6, the Financial StatutesAmendment Act (the ‘‘Act’’), which amends the FinancialInstitutions Act, the Personal Property Security Act, and theSecurities Act, received Royal Assent on March 31, 2010, onwhich date sections 3(a), 8, 16, 29, 30, and 33 of the Actcame into force.Sections 3(b) and (c), 6, 7, 11, 15(a), 17 to 19, 21 to 24,26(a), 27, 28(a), 31, and 32 come into force onDecember 31, 2010. Section 23 of the Act will add, to theRight of Shareholders To Receive FinancialStatements of Subsidiary Corporations

Corporate Brief 4otherwise, against what the shareholder might benefit fromthe requested disclosure. It also alleged that the applica-tions judge had erred in finding that disclosure would notresult in detriment to the company.The Court of Appeal began by reviewing the commen-tary on the two-fold purpose of shareholder disclosure.The first purpose is to permit the shareholders and thesecurities market generally to evaluate the relative strengthsand weaknesses of an enterprise, in order to makeinformed decisions with respect to investments. Second,the provision of adequate information allows shareholdersto effectively evaluate the performance of the corporation’sdirectors and officers. The Court noted that in this case, therespondent was not asking for information which wouldgenerally not be available to a shareholder. Rather, he wasseeking to examine the financial statements of the parent’ssubsidiary companies, which the parent was required bystatute to keep at its registered office, and which shareholderswere entitled to inspect at the annual generalmeeting. The Court was not convinced that the applicationsjudge made an error of law. In the Court’s view, thequestion before the applications judge was not the precisedelineation of the meaning of the term ‘‘detriment’’, butwhether the appellant company had met its onus of establishingdetriment which would warrant the granting of reliefagainst disclosure of the subsidiary financial statements.The Court of Appeal concluded that the applications judgehad not unduly narrowed the definition of detriment andfurther, that he had not committed an error by failing toengage in a balancing of any detriment to the companyagainst potential benefit to the shareholder. There was, inthe Court’s view, no basis in the statutory language to supportthe view that the applications judge was required toengage in such a balancing type test. Rather, the judge isrequired simply to assess the evidence to determine if therequested disclosure would be detrimental to the companyor a subsidiary. The applications judge carried outsuch an assessment and, in doing so, he committed noreviewable error of law.The Court of Appeal then considered whether, asalleged by the appellant, the applications judge had erredin concluding that the company had not met the onus ofshowing detriment. The appellant company alleged thatthe applications judge had erred by concluding that therewas no evidence that the shareholder would disclosefinancial information which he received, and had alsoerred in failing to recognize that the shareholder wasseeking subsidiary financial information for an improperpurpose. The Court of Appeal rejected both allegations.The shareholder, in his testimony, had indicated that hewould share any information received with his legaladvisers and accountants. The applications judge wasaware of this testimony and imposed a condition on theshareholder prohibiting him from sharing any informationreceived with anyone else. The Court of Appeal found itnoteworthy that the shareholder had not appealed againstthat confidentiality order and also that it was not suggestedthat he had breached its terms. With respect to the allegedimproper purpose, the Court of Appeal held that thestatute clearly gave the shareholder the right to examineand make copies of financial statements of the company’ssubsidiaries, unless the company could obtain relief from acourt. The shareholder is not required to satisfy the com-pany of the legitimacy of his request or to negotiate anyterms under which he may be given access. Rather, it is thecompany which bears the onus of persuading the Courtthat providing the shareholder with his statutory rightwould cause detriment to the company or to its subsidi-aries. The applications judge found that it did not meet thatonus, and there was no basis for a finding of error in hisreasons for doing so.Minas Basin Holdings Limited v. Paul Bryant EnterprisesLtd. and the Registrar of Joint Stock CompaniesALBERTA CORPORATIONS LAW GUIDE 79,326BRITISH COLUMBIA CORPORATIONS LAW GUIDE 78,750CANADA CORPORATIONS LAW REPORTER 200,907CANADIAN CORPORATE SECRETARY’S GUIDE 51,187ONTARIO CORPORATIONS LAW GUIDE 51,563Liability of Directors for Unremitted SourceDeductions● ● ● Ontario Court of Appeal ● ● ●A company knownas Danso Enterprises Ltd. (‘‘Danso Enterprises’’) was incor-porated in 1997 by the brother of the applicant LisaDanso-Coffey (‘‘Danso-Coffey’’), and she was named adirector of the corporation without her knowledge.Danso-Coffey was not involved in the incorporation of thecompany and never signed any forms or paperwork inrelation to the company’s incorporation or operations.While shares of the company were placed in her name,she never received any of those shares. She was neveremployed by the company, never had any operationalinvolvement, and never received any income or benefitsfrom the company. In 2004, the company became insol-vent and eventually filed for bankruptcy. An assessmentwas issued against Danso-Coffey with respect to retail salestax that the corporation had failed to remit. She brought anapplication for a declaration that she was not a director ofthe company and therefore not liable for assessment (seeONTARIO CORPORATIONS LAW GUIDE 51,497, CANADA CORPORA-TIONS LAW REPORTER 200,841, ALBERTA CORPORATIONS LAW GUIDE79,260, CANADIAN CORPORATE SECRETARY’S GUIDE 51,121, andBritish Columbia Law Guide 78,684). It was held that affi-davit evidence established that Danso-Coffey had neverbeen a director of the company. The Business Corpora-tions Act (the ‘‘Act’’) required that a director be elected bythe shareholders and that the director consent to his or herappointment in writing. Neither statutory requirement hadbeen satisfied and Danso-Coffey was therefore not adirector. The Court possessed inherent and statutory dis-cretion to grant declaratory relief to Danso-Coffey and suchrelief was granted. The Crown appealed from that decision.

5Corporate BriefThe appeal was allowed. The Court of Appeal held thatthere were several issues to be determined on the appeal,and it identified the following as issues for determination.First, whether the Minister’s assessment of Danso-Coffeywas ‘‘unlawful’’; whether there was a gap within the legisla-tion which prevented her from seeking relief within theparameters of the taxing statute; whether, if there was nosuch gap, the Court possessed the jurisdiction to providedeclaratory relief; and, finally, whether, if such jurisdictionexisted, the applications judge had correctly exercised thatdiscretion.company. That conclusion did not, however, invalidate theoriginal assessment, as the taxing statute provided that anyassessment issued was deemed to be valid despite anyerror or omission contained within it. As the original assessmentwas valid, the Minister’s appeal was allowed and thedeclaration that Danso-Coffey was not a director wasupheld. However, the Court of Appeal noted that the dec-laration that Danso-Coffey was never a director of the cor-poration meant that the factual basis on which the assess-ment was made no longer existed. Consequently, it wasopen to Danso-Coffey to request that the Minister reassessher, taking into account her due diligence defence basedon her mistaken belief that she was not listed as a directorof the company.The Court first considered the issues relating to theassessment under the sales tax legislation, and the questionof whether Danso-Coffey was entitled to seek reliefwithin the parameters of that statute. It held that the trialjudge had erred in finding that the assessment wasunlawful. In the Court of Appeal’s view, it appeared that theALBERTA CORPORATIONS LAW GUIDE 79,327Minister was under the impression that in lawDanso-Coffey could not raise the defence that she hadBRITISH COLUMBIA CORPORATIONS LAW GUIDE 78,751never been a director and so it issued the Notice of Assessment.There was no allegation that the Minister abused itsCANADA CORPORATIONS LAW REPORTER 200,908power or that Danso-Coffey’s objection was not taken intoaccount. The assessment was validly issued, and the trial CANADIAN CORPORATE SECRETARY’S GUIDE 51,188judge’s conclusion that it was unlawful was in error. Theappellate Court then considered whether, as found by the ONTARIO CORPORATIONS LAW GUIDE 51,564trial judge, there was a ‘‘functional gap’’ in the legislationwhich prevented Danso-Coffey from raising the defencethat she had never been a director of the corporation, andconcluded that no such functional gap existed. The Court● ● ● Tax Court of Canada ● ● ●The appellant WilliamCampbell (‘‘Campbell’’) was the sole director and share-holder of a business, Complete Rent-Alls Limited (‘‘CRL’’).While CRL had been successful for 25 years, it began toexperience financial difficulties in the late 1980s. Until thattime, Campbell had been involved primarily in the man-agement of CRL but when financial problems occurred, hebecame involved at all levels of the business. In 1994, CRLmade a proposal in bankruptcy which was accepted by itscreditors, including the Canada Revenue Agency (‘‘CRA’’).Before making the proposal, and for about two years afterthat time, the company had met substantially all of itsremittance obligations. Difficulties with source deductionsbegan in 1996. Steps were taken to address the problem,but CRL eventually ceased operations in 1999. Campbellhad remained the sole director of the company untilDecember 31, 2000, at which time he indicated that he hadresigned that position by means of a handwritten letter.Notwithstanding, in 2006 the CRA issued an assessmentagainst him for source deductions owed by CRL. Campbellappealed against the assessment.reviewed the jurisprudence with respect to a defence ofdue diligence and found that such defence could include‘‘holding a reasonable belief in a mistaken set of facts’’. Inthis case, although Danso-Coffey reasonably believed thatshe was not listed as a director of her brother’s company,she was mistaken. Such reasonable belief would satisfy therequirements of a due diligence defence, andDanso-Coffey could have raised such defence to an assessmentunder the taxing statute. Finally, the Court consideredwhether the trial judge had erred in exercising his inherentdiscretion to grant declaratory relief, and concluded thathe had. The Court held that, in considering whether thecourt has jurisdiction to grant declaratory relief outside thestatutory framework, regard must be had to the purpose ofthe legislation and its wording. A functional gap in thelegislation would be an example of a jurisprudential reasonfor the court to exercise its inherent jurisdiction. However,the Court had found that no such functional gap existedand there was therefore no justification for the trial judge’sexercise of inherent jurisdiction. The Court of Appeal con-cluded that the legislature intended disputes concerningthe validity of an assessment of tax to be resolved withinthe framework of the taxing statute.Danso-Coffey v. Her Majesty the Queen in Right ofOntarioLiability of Director for Unremitted SourceDeductionsThe appeal was allowed. Campbell disputed thevalidity of the assessment on the basis that, since he hadresigned his position as CRL’s director in 2000, the assess-ment had been issued outside the statutory two-year limitationperiod provided for in the Income Tax Act (the‘‘Act’’). In the alternative, Campbell took the position thathe had, as required by the Act, exercised the necessary dueThe Court of Appeal then considered the question ofwhether the trial judge was correct in his conclusions thatDanso-Coffey was never a director of the corporation. Onthe basis of the unchallenged evidence concerningDanso-Coffey’s lack of involvement with the corporation,the Court saw no reason to interfere with the applicationjudge’s declaration that she was never a director of the

Corporate Brief 6diligence to prevent the failures to remit the required CANADA CORPORATIONS LAW REPORTER 200,909source deductions to the CRA.CANADIAN CORPORATE SECRETARY’S GUIDE 51,189The Court first examined the question of whetherCampbell had in fact resigned his position as director in ONTARIO CORPORATIONS LAW GUIDE 51,565December 2000. The evidence showed that there weretwo separate handwritten letters of resignation which hadbeen filed with the Registrar of Deeds. However, neither Unanimous Shareholders’ Agreement andletter had been properly filed or date-stamped and so it Arbitrationwas not possible to determine when they had beenwritten. The Court reviewed the requirements which were ● ● ● Manitoba Court of Appeal ● ● ●James Courtimposed under the applicable provincial legislation with (‘‘Court’’), Christos Filopoulos (‘‘Filopoulos’’) and Brianrespect to a director’s resignation. While in most circumaccountingHnatiuk (‘‘Hnatiuk’’) were members of a professionalstances, it is not necessary for a resigning director to file thepractice. They entered into a partnership agree-letter of resignation with the provincial corporate registry, ment (‘‘PA’’) and they and their respective corporationsdifferent considerations apply where the company from also became parties to a unanimous shareholders’ agree-which the director is resigning is a tax debtor. Newfoundthroughment (‘‘USA’’). The accounting practice was carried onland and Labrador corporations legislation contains a prowhicha professional corporation (the‘‘corporation’’)vision requiring the director of such a company who seekswas also a party to the USA.to resign his or her position to advise the CRA of thatresignation. The Court reviewed the circumstances of Soon after forming the partnership, differences aroseCampbell’s purported resignation and concluded that among the parties and, in March 2007, Court and Filoclearevidence as to the date of such resignation was poulos decided to end the professional relationship withlacking. The onus was on Campbell to adduce evidence in Hnatiuk. They served notices on him under both the PAsupport of the authenticity of the letter of resignation, and and the USA, bringing the relationship to an end. Thethe Court concluded that he had not done so. As well, notice given under the USA also stated that Court andeven if he had validly resigned on December 31, 2000, the Filopoulos were exercising their right to have the corpora-Court was of the opinion that he remained a de facto tion purchase the shares held by Hnatiuk and his corporadirectorof CRL after that date. Campbell had not informed tion. The USA contained a provision respecting a sharethird-party creditors or the CRA that he had resigned, either valuation process, but this process was not followed.in the course of a pre-assessment proposal in 2004 or Shortly thereafter, Hnatiuk and his corporation applied forduring meetings held in 2005.an order liquidating the professional corporation. They alsosought a declaration that, under the terms of the USA, theyHaving concluded that Campbell had not resigned as were entitled to a one-third share of the assets of thedirector in December 2000, the Court went on to consider corporation and that the valuation and accounting proce-whether he had, in his actions as director, exercised the dures set out in the USA had to be followed. The other twonecessary due diligence. It noted that the jurisprudence parties applied for a stay of the liquidation application onprovides for an objective/subjective test, under which a the basis that the matter was, under the terms of the USA,due diligence defence is a question of fact to be deterthatto be submitted to arbitration. The applications judge heldmined with reference to the personal knowledge, skills andwhile the overriding issue was the valuation of Hna-experience of the individual director, together with the tiuk’s interests and the valuation of those interests, thepositive steps and actions that were taken to prevent the issue before him was whether to grant the stay. He heldremittance shortfalls. In this case, evidence of the steps that the arbitration clause included in the USA was suffi-taken was provided by Campbell and by the former chief ciently broad to include the issue in dispute and the stayfinancial officer of CRL. That evidence showed that Campthatwas granted. Hnatiuk and his corporation appealed frombell had taken all of the actions outlined in the case lawstay.required to establish a due diligence defence. He had alsotaken most of the steps which the CRA had identified in a The appeal was allowed in part. The first issue forCRA policy document as those which could be taken by a determination by the Court of Appeal was whether to givedirector to prevent remittance failure. In the Court’s view, effect to the respondents’ argument that section 7 of theCampbell had, throughout the entire period, involved himlowerArbitration Act applied to preclude any appeal from theself directly with a hands-on, proactive approach inCourt’s decision. The appellate Court reviewed theattempting to secure and comply with payment of CRL’s jurisprudence interpreting that section before concludingremittances. The Court concluded that Campbell was, as a that an appeal was possible. In the Court’s view, the appli-result, entitled to avail himself of the due diligence cations judge misdirected himself on the nature of thedefence, and his appeal was therefore allowed.dispute, and it therefore followed that appellate interven-tion for the purpose of properly characterizing the disputeCampbell v. Her Majesty the Queen was not barred by subsection 7(6). Further, a failure tointervene, by construing section 7 too literally, would resultALBERTA CORPORATIONS LAW GUIDE 79,328in an ineffective arbitration process. The arbitrator wouldhave to focus on a subsidiary question only, while theBRITISH COLUMBIA CORPORATIONS LAW GUIDE 78,752fundamental dispute remained outside his or her purview.

7Corporate BriefSuch a result could not, in the Court’s view, have been dant Reuben Rivas (‘‘Rivas’’), who controlled Venture,what was intended by the legislature in enacting section 7. entered into a shareholders’ agreement with Link andA discretionary order which stays a court proceeding and other executives of the company (the ‘‘managementrefers a dispute to arbitration cannot be immune from shareholders’’). Under that agreement, Link received sharesappellate review if failure to review would send a wrongly representing 9% of the issued common shares of Venture.described dispute to arbitration, with the likely result that Venture was also a party to the shareholders’ agreement.the process would be futile.The agreement provided, in part, that if Rivas received anoffer to purchase all of a majority of his shares, the man-Having determined that an appeal from the applica- agement shareholders would have ‘‘piggyback rights’’tions judge’s decision was possible, the Court of Appeal which gave them the right to require that their shares bewent on to outline the reasons for its conclusion that the sold to the prospective purchaser in the same proportionnature of the dispute had been mischaracterized by the as Rivas’s shares and on the same terms. Another provisionapplications judge. The appellate Court held that it was of the shareholders’ agreement gave Venture the right tonecessary to construe the USA in its entirety in order to give purchase all of a management shareholder’s shares on theit proper meaning. The Court reviewed the terms of the occurrence of a ‘‘terminating event’’, which included theUSA and the actions taken by the parties and concluded termination of the shareholder’s employment. In the eventthat while the question of the valuation of Hnatiuk’s shares that the termination was without cause, the sale price ofwas an issue to be determined, it was in fact a secondary or the shares was 100% of their net book value. Where thesubsidiary issue. The real dispute between the parties was termination was for cause, the sale price of the shares wasthe difference in their interpretation of the terms of the $1.USA with respect to the termination of their business relationship.Specifically, the nature of the dispute was whether In February 2005, Venture dismissed Link from histhe respondents, having terminated the USA, had an employment with the company, allegedly for cause. Inenforceable right to purchase the Hnatiuk interests and May 2005 Rivas informed Link that he was exercising hiswhether Hnatiuk and his corporation were obliged to sell option to purchase Link’s shares for $1. Link disputedin the absence of the an ‘‘agreed upon annual valuation Rivas’s right to do so, and no sale took place. In Octoberamount’’ or whether, in such circumstances, Hnatiuk had 2005, the directors of Venture passed a resolutionthe right to apply for dissolution of the corporation. Folthem,purchasing Link’s shares at the price of $1 and cancellinglowing its review of the terms of the USA, the appellatewith retroactive effect from May 2005. In April 2006,Court concluded that those terms were open to a number an unrelated company purchased Venture, with the termsof interpretations by the arbitrator. It held as well that the of the sale set out in a Share Purchase Agreement. Thearbitration clause in the USA was broad enough to encomagementvendor shareholders included Rivas and two of the man-pass the dispute, which was one ‘‘touching on the conspecifiedshareholders. The Share Purchase Agreement alsostruction, meaning or effect of the USA or the rights orthat certain share options, including those heldliabilities of the parties’’. The applications judge had been by Link, were to be redeemed or repurchased before thecorrect in referring the matter to arbitration, but the primaryclosing of the sale.issue for determination by the arbitrator was changedas determined by the appellate Court.Link brought an action for wrongful dismissal and foramounts which he claimed arising from his ownership ofHnatiuk and 5239886 Manitoba Ltd. v. Court, Filopoulos, shares of the company and its sale, as well as amountsCourt Filopoulos Hnatiuk Certified Management related to the options he held for future share acquisitions.Accountants Ltd., 4507241 Manitoba Inc. and 4511034 At trial, the judge held that Link had been wrongfully dis-Manitoba Inc. missed and that he was entitled to damages in lieu ofnotice. The trial judge also held that Link was entitled,ALBERTA CORPORATIONS LAW GUIDE 79,329under the terms of a unanimous shareholders’ agreementand a share option agreement, to compensation for hisBRITISH COLUMBIA CORPORATIONS LAW GUIDE 78,753shares relating to the sale of the company, an amountCANADA CORPORATIONS LAW REPORTER 200,910representing a dividend paid on such shares and compensationfor the value of shares covered by the share optionCANADIAN CORPORATE SECRETARY’S GUIDE 51,190agreement. Venture Steel appealed from the order relatingto compensation amounts payable to Link arising from hisONTARIO CORPORATIONS LAW GUIDE 51,566share ownership or his share acquisition options.The appeal was allowed in part. The appellants arguedthat the trial judge had erred in finding that Link was aEmployee Shareholder Entitled toshareholder of the company in April 2006, when the com-Compensation Where Attempts Topany was sold. Its argument was based on its interpretationPurchase Shares for Cancellation Invalid of the provisions of the shareholders’ agreement dealingwith the required sale of shares on the occurrence of a● ● ● Ontario Court of Appeal ● ● ●William Link ‘‘terminating event’’, with the company arguing that Rivas’s(‘‘Link’’) was an employee of Venture Steel Inc. (‘‘Venture’’), attempt to purchase Link’s shares in May 2005 was validholding the position of Vice-President of Sales. The defen- and that the issue of the price to be paid was a separate

Corporate Brief 8step. The appellate Court disagreed, finding that the priceat which the purchase option is exercised was a critical partof the exercise of the option. There was no discussion inthe offer of an alternative scenario of Link being dismissedwithout cause. No purchase price was ever paid, and Linknever relinquished his shares. The Court of Appeal wassatisfied that the letter sent by Rivas in May 2005 did notconstitute a valid purchase of Link’s shares. The resolutionpassed by Venture’s directors which purported to purchaseLink’s shares for cancellation effective May 2005 was simi-larly ineffective. The trial judge had properly held that Linkwas a shareholder of the company when it was sold inApril 2006.The appellants also argued that Link was not entitledto benefit from the sale of the company because the necessarypreconditions for his claim had not been met andthat, in any event, he was not entitled to recover as againstthe company itself, because it was not a party to the shareholders’agreement. The Court of Appeal disagreed, findingboth that Venture was party to the agreement and that itwas ‘‘integrally involved’’ in the events which led to Linkbeing denied the opportunity to participate in the proceedsof the share sale. In the Court’s view, Rivas and theother selling shareholders could not have excluded Linkfrom the sale proceeds but for the wrongful actions ofVenture. In particular, Venture’s dismissal of Link fromemployment permitted Rivas to claim to purchase Link’sshares for $1. Link was a shareholder of the company inMay 2006 and was entitled to participate in the proceedsof the sale of the company. Venture was a party to theshareholders’ agreement and the trial judge was correct inconcluding that the company was liable to Link for thevalue of his shares under the provisions of that agreement.The Court of Appeal then considered whether the trialjudge was correct in concluding that Link was entitled tocompensation relating to the share options he held, andconcluded that he was not. Link’s interest in those shareswas in the nature of an option only, one which he was notentitled to exercise until after July 15, 2009. As well, theCourt held that it was not clear, on the evidence, on whatshares a dividend had in fact been declared. In the circum-stances, there was not sufficient evidence to support thetrial judge’s award of damages to Link in respect of thedividend payment.Link v. Venture Steel Inc. and Rivas; Venture Steel Inc.and 1452938 Ontario Limited, carrying on businessunder the firm name and style of Venture Steel, and thesaid Venture Steel v. LinkALBERTA CORPORATIONS LAW GUIDE 79,330BRITISH COLUMBIA CORPORATIONS LAW GUIDE 78,754CANADA CORPORATIONS LAW REPORTER 200,911CANADIAN CORPORATE SECRETARY’S GUIDE 51,191ONTARIO CORPORATIONS LAW GUIDE 51,567Liability of Director for Uremitted TaxAmounts● ● ● Tax Court of Canada ● ● ●The appellant MichaelVrsic (‘‘Vrsic’’) was the director of a company, A.C. StandardIndustrial Supply Ltd. (the ‘‘Company’’). The day-to-daybookkeeping operations of the company, including taxremittances, were carried out by a long-term employeeunder Vrsic’s supervision. While the Company was initiallysuccessful, it ran into financial difficulties after 2001 and, by2006, the Company was in arrears with respect to its taxremittances. While cheques had been prepared by thebookkeeper for such remittances, they were never submittedto the Canada Revenue Agency (‘‘CRA’’). When Vrsicbecame aware of this, he confronted the bookkeeper, whothen resigned her employment with the Company. Vrsicthen tried a number of means to bring the Company intocompliance with its remittance obligations, includingattempts to sell the Company’s inventory and assets, andthe investment of his own funds, but was ultimately unsuc-cessful in doing so.In 2007, the CRA issued an assessment of the Com-pany’s tax liability for the first two quarters of that year. Asthe Company had not filed any returns for those twoquarters, the CRA’s assessment was based on past saleshistory, without taking into account any deductions orcredits against that tax liability. The CRA was unable tocollect the amounts owing from the Company and anassessment was issued against Vrsic as its director. Heappealed from that assessment.The appeal was allowed. Vrsic contested the assess-ment against him on two grounds: first, that he had actedwith due diligence in his role as director with respect to theCompany’s remittance obligations and second, that theassessments issued against the Company were themselvesincorrect in that they significantly overstated the Com-pany’s sales figures for the first two quarters of 2007.The Court first considered Vrsic’s defence of due diligence.It noted that, as held in the jurisprudence, while it isalways possible to find that a director could have takensome further step to prevent a remittance failure, the testof due diligence under the Excise Tax Act is not whetherevery conceivable step has been taken, but rather whatsteps to prevent failure ‘‘a reasonably prudent personwould have exercised in comparable circumstances’’. TheCourt reviewed Vrsic’s actions in that regard over theperiod during which he was a director of the Company. Itwas satisfied, based on the evidence, that Vrsic had actedwith due diligence up to the end of 2005. Over that period,he had entrusted the responsibility for tax remittances to atrusted long-term employee and had regularly asked herfor confirmation that such remittances were current. Inaddition, when CRA auditors visited the Company, Vrsicspoke to them to ensure that ‘‘all was well’’. The Court wassatisfied that, overall, Vrsic had acted with due diligence upto the last quarter of 2005. It was during that quarter, however,that the first of the remittance cheques were notforwarded to the CRA, and the Court noted that Vrsic could

9Corporate Briefhave detected that fact by a review of the bank reconcilia- sales of the Company during the first two quarters of 2007tions alone. He was also told explicitly during 2006 that had dropped by over 75%. Consequently, the Court contherewas a problem with remittances. While Vrsic took cluded that the assessment issued by the CRA was basedcertain steps after that point, those steps were, in the on sales four or five times greater than would be accurate.Court’s opinion, directed more toward looking after the The Court ordered that the amount payable for thoseCompany’s employees than ensuring that the CRA remit- quarters therefore be reduced from $20,000 per quarter totances were paid. Further, his actions in attempting to sell $4,500 per quarter. It held, however, that in the absence ofinventory and assets were not the exercise of due diligence any evidence substantiating credits or deductions whichto prevent remittance failure, but an attempt to make good the Company might have claimed for those periods, noon the debt after the fact. The Court concluded that while allowance for such credits or deductions could be made.Vrsic could rely on the due diligence defence up to the The assessment against Vrsic was referred back to the Minendof 2005, his actions subsequent to that time did not ister for reassessment on the basis that there was no liameetthe requisite standard of care.bility for the last quarter of 2005 and that the liability for thefirst two quarters of 2007 should be reduced as directed byThe Court then turned to a consideration of whether it the Court.was open to Vrsic to challenge the underlying corporateassessment for the first two quarters of 2007 and concludedthat it was. While the jurisprudence was not entirelyVrsic v. Her Majesty the Queenconsistent on that point, the Court held that both the statutorylanguage and the requirements of natural justiceALBERTA CORPORATIONS LAW GUIDE 79,331leave it open to a director to challenge an underlyingassessment where the company has not done so itself. TheBRITISH COLUMBIA CORPORATIONS LAW GUIDE 78,755assessment issued by the CRA was based on the Company’shistorical sales figures, without considering any CANADA CORPORATIONS LAW REPORTER 200,912offset or reduction for tax credits or deductions. While it isopen to the government to make an arbitrary assessment, CANADIAN CORPORATE SECRETARY’S GUIDE 51,192it is then open to the taxpayer to disprove that assessment.Vrsic’s testimony, which the Court accepted, was that the ONTARIO CORPORATIONS LAW GUIDE 51,568Continuing Legal Education OpportunityThe Six-Minute Business Lawyer 2010Are you prepared for the potential increased demand for your services as the Canadian economy turns the corner towardsrecovery? This program will prepare you to handle various business deals by providing updates on key legislative changesand case law, including recent developments in Ontario corporate law reform, and by exploring trends in negotiatingpurchase and sale agreements, including the purchase from a receiver. You will leave this program armed with the practicalinformation you need to best serve your next business clients.Tuesday, June 1, 2010 (9:00 a.m.–12:00 p.m.)Chair: Michael P. Whitcombe, McMillan LLPPlease go to http://ecom.lsuc.on.ca/cle/product.jsp?id=CLE10-0060101 for more information.