Reasonable Expectations Cannot Be Ignored

Reasonable Expectations Cannot Be Ignored

April 15, 2021

By Jonathon Clark

Minority shareholders in a closely held private corporation may be entitled to have a reasonable expectation of sharing in the management and operation of the business, regardless of their employment status.

Family businesses can be wonderful joint adventures, until events occur which shatter those bonds.

LDS Capital Corporation v. Smalley is a recent illustration of what can happen when family members in business together have a falling out.

Dewane and Dean are brothers. Dewane bought the family business from their father. A short time later, Dean through a holding company (LDS) bought a minority interest (14.64 per cent), and worked for the company for thirty years.

Dewane was president of the company, and its directing mind. Dean was a director and vice president, with particular responsibility for computer systems and community outreach.

Over time the business grew from a local company to a global business. Both brothers profited from this success.

Beginning in 2012, Dewane started to reduce Dean’s responsibilities, and in 2017, terminated his employment. Dean sued for wrongful dismissal. His action was settled, but only related to his employment based claims.

Dean remained a director and shareholder, but, as unfortunately happens in too many cases, he was frozen out – he received no income or information, and had no input into management.

He sued for an oppression remedy, which is available under the Business Corporations Act for conduct which unfairly prejudices or disregards a stakeholder’s interests.

Dean alleged, among other things, that Dewane reduced the dividends payable to LDS, reduced Dean’s salary, paid excessive salaries to Dewane and members of his family, paid personal expenses of Dewane and his family, paid his holding company performance bonuses under the guise of shareholder loans and failed to provide audited financial statements to LDS.

Dean and LDS sought a buyout of the LDS shares in the company, without a minority discount, plus compensation for the alleged improper payments to Dewane and family.

The case raises interesting issues about share valuation, but the focus of this article is on the threshold question of whether there was oppressive conduct, and in particular, the definition and importance of determining the Applicant’s reasonable expectations.

The oppression remedy requires either oppressive conduct, which is usually equated with bad faith, or conduct which is “unfairly prejudicial”, which is a lesser standard of moral misconduct, often simply ignoring an interest as if it had no importance, disregarding the stakeholder’s reasonable expectations.

The court therefore looked at Dean’s reasonable expectations.

Prior cases provide guidance as to what sort of things make expectations reasonable, such as:

  • General commercial practice,
  • The nature of the corporation,
  • The relationship between the parties,
  • Past practice,
  • Steps the claimant could have taken to protect it,
  • Representations and agreements, and
  • The fair resolution of conflicts between corporate shareholders.

In the LDS situation, it was important to remember that Dean’s expectations as an employee were already dealt with, and not relevant to the issue of oppression.

Dean:

  • did not expect to be excluded from the business, nor to have his involvement in operations reduced unilaterally
  • did not expect to be denied office space and to be required to work from home
  • did not expect to be terminated and requested to sell his shares to Dewane
  • had trusted Dewane with the financial management, and until 2017 had no reason to request financial statement or a look at the books
  • only became aware of the extent to which Dewane and his family had disproportionately benefited after 2017
  • that, in return for the risks associated with being a director and guarantor on the company’s line of credit, that he would share in the company’s success

LDS, as shareholder reasonably expected a proportionate share of the profits.

Applying these considerations to the evidence in the LDS case, the court had no trouble determining that Dean and LDS had:

a reasonable expectation that the majority shareholder would manage the Company bearing in mind the interest of its minority shareholder. Instead, the majority shareholder operated the Company with a view to enhancing its own interest and the interests of its principal and his family, with little regard for the Applicants’ interests. Essentially, from about 2012 onward, Dewane operated the Company as if there were no shareholder other than Smalley Capital and no other officer or director.

The judgment goes on to order that Dewane buy the LDS shares, on terms favourable to Dean, and pay most of the disputed amounts to Dean or LDS.

If you are the controlling shareholder of a family business, or any closely held private corporation, this case is a timely reminder to ask yourself whether you know what your stakeholders reasonable expectations are. Once you figure that out, it is a worthwhile exercise to ask yourself whether or not you are meeting those expectations, since simply ignoring them, or treating them as unimportant, may be oppressive conduct, and lead to a costly lawsuit.

If you are a minority shareholder, director or other stakeholder, do you know what your expectations are? Are they reasonable, using the guidelines set out in LDS? If not, should you consider pursuing an oppression remedy?