Med-Chem Health Care Limited v. Misir et al. Wong et al. v. Med-Chem Health Care Limited et al. [Indexed as: Med-Chem Health Care Ltd. v. Misir]
103 O.R. (3d) 769
2010 ONCA 380
Court of Appeal for Ontario,
Goudge, MacPherson and MacFarland JJ.A.
May 27, 2010*
- This judgment was recently brought to the attention of the editors.
Corporations -- Directors -- Legal expenses -- Company suing former directors for breaching their duties to company -- Company having obligation to make advances to defendants of their legal expenses prior to conclusion of litigation -- By- law of company requiring company to indemnify eligible individuals in all circumstances in which Ontario Business Corporations Act allows indemnification -- Section 136 of OBCA providing for advancement of those legal costs that may be indemnified by corporation -- Advancement provisions of ss. 136(2) and 136(4.1) of OBCA extending to former directors -- Motion judge not erring in exercise of her discretion in ordering that advances be paid before being assessed under Solicitors' Act -- Business Corporations Act, R.S.O. 1990, c. B.16, s. 136 -- Solicitors' Act, R.S.O. 1990, c. S.15.
The plaintiff sued three of its former directors and its secured lender for breaching their duties to the company. The defendants moved successfully for an order requiring the plaintiff to make advances from time to time of the legal expenses they were incurring in defending the action, even though the action had not yet been concluded. The plaintiff appealed.
Held, the appeal should be dismissed.
The motion judge did not err in finding that a by-law of the plaintiff, coupled with s. 136 of the Ontario Business Corporations Act (the "OBCA"), required the plaintiff to make the advances to the former directors and that its loan agreement with its secured lender required the same result. The by-law clearly required the plaintiff to indemnify eligible individuals in all those circumstances in which the OBCA allows indemnification. Section 136(2) of the OBCA allows the corporation to pay advances of the legal expenses that the corporation may indemnify under s. 136(1). Section 136(4.1), under which these proceedings were brought, allows the corporation to do the same (with the court's approval) if the action is brought by or on behalf of the corporation itself and the individuals are made parties to it by virtue of their association with the corporation. The advancement provisions of ss. 136(2) and 136(4.1) extend to former directors. The motion judge was entitled to find that the mala fides of the former directors had not been established, so that they were not disqualified from being indemnified under s. 136(2). In exercising her discretion under s. 136(4.1), she did not err in failing to consider whether there was proof of an inability to pay for the litigation without advances, the presence of insurance to fund them and the defendants' delay in seeking the advances. Neither the by-law nor s. 136 of the OBCA requires an inability to pay or the presence of insurance coverage, and the defendants' delay paled in comparison with the plaintiff's own delay in commencing the action itself. [page770]
The motion judge did not err in finding that the loan agreement between the plaintiff and its secured lender required the plaintiff to make the advances in question.
The motion judge was within her discretion in providing for a process that required the advances to be paid before being assessed for reasonableness under the Solicitors' Act.
APPEAL from the order of Hoy J. of the Superior Court of Justice dated May 26, 2009 requiring the plaintiff to make advances to the defendants of their legal expenses.
Cases referred to Blair v. Consolidated Enfield Corp., 1995 CanLII 76 (SCC), [1995] 4 S.C.R. 5, [1995] S.C.J. No. 29, 128 D.L.R. (4th) 73, 187 N.R. 241, 24 B.L.R. (2d) 161, 58 A.C.W.S. (3d) 230
Statutes referred to Business Corporations Act, R.S.O. 1990, c. B.16, s. 136 [as am.], (1), (2), (3), (4.1) Solicitors' Act, R.S.O. 1990, c. S.15 [as am.]
Kevin D. Toyne, for appellant. Patricia Jackson and Emily Head, for respondent Howie C. Wong. David S. Steinberg and Shantona Chaudhury, for respondent Devendranauth Misir. Mary Jane Stitt, for respondents Richard Kinlough, CCFL Subordinated Debt Fund and Company, Limited Partnership, and CCFL Mezzanine Partners of Canada Limited.
The judgment of the court was delivered by
[1] GOUDGE J.A.: -- The appellant Med-Chem Health Care Limited ("Med-Chem") has sued the respondents, three of its former directors and its secured lender, for breaching their duties to the company. The respondents moved successfully for an order requiring Med-Chem to make advances from time to time of the legal expenses they have incurred in defending the action, even though the action has not yet been concluded.
[2] In this court, the appellant's position is that the motion judge erred in finding that (i) Med-Chem's By-law No. 12, coupled with s. 136 of the Ontario Business Corporations Act, R.S.O. 1990, c. B.16 ("OBCA"), requires Med-Chem to make these advances to the former directors; and (ii) Med-Chem's loan agreement with its secured lender requires the same result. The appellant does not contest its obligation to indemnify the respondents at the conclusion of the litigation, but disputes its obligation to make advances before that time. [page771]
[3] For the reasons that follow, which closely parallel those of the motion judge, I agree with her conclusion. I would therefore dismiss the appeal.
The Facts
[4] In December 1996, the respondents Misir, Wong and Kinlough became directors of Med-Chem when the respondent CCFL Subordinated Debt Fund and Company, Limited Partnership ("CCFL") provided funding to enable Med-Chem to complete an initial public offering. In addition to being directors, Mr. Misir was an officer of Med-Chem, Mr. Wong was its corporate solicitor and Mr. Kinlough was the president of the respondent CCFL Mezzanine Partners of Canada Limited ("CCFL Mezzanine"), the general partner of CCFL.
[5] At that time, Dr. Sultan Mahmood Alvi was chairman of Med-Chem's board of directors, as well as its president and chief executive officer. He was also the company's controlling shareholder.
[6] Over the next two years, Med-Chem's financial situation deteriorated badly, and on February 1, 1999, it was adjudged bankrupt. By that time, Mr. Kinlough, Mr. Wong and Mr. Misir had all resigned as directors.
[7] Med-Chem is now a discharged bankrupt. Its claim in this action, which is driven by Dr. Alvi, is that the respondents breached their duties to Med-Chem and were responsible for its bankruptcy.
[8] Since at least 1998, Dr. Alvi has asserted that CCFL was responsible for Med-Chem's financial problems. During the course of Med-Chem's bankruptcy, he sought to pursue this claim by having the trustee commence an action against CCFL very similar to the current action. The trustee declined to do so, having received an opinion from external counsel that Med-Chem had no case against CCFL.
[9] Instead, in 2004, Dr. Alvi commenced an action in his personal capacity as a shareholder against these respondents, alleging that their wrongful conduct occasioned Med-Chem's bankruptcy. He ultimately discontinued that action. On June 9, 2005, the former directors and CCFL obtained a court order indemnifying them for the costs they had incurred in defending Dr. Alvi's shareholder claim.
[10] The appellant commenced the present action on November 23, 2007. While the action is still at the pleadings stage, the former directors and CCFL have already incurred significant expenses in defending it. It is those expenses that they now seek to recover. [page772]
The Decision of the Motion Judge
[11] The motion judge dealt first with the advance of expenses incurred by the former directors. She concluded that, subject to the court's approval, Med-Chem's By-law No. 12 and s. 136 of the OBCA require the company to reimburse these respondents for these expenses. She then concluded that, in all the circumstances, she should exercise her discretion to approve the advances and ordered that they be paid.
[12] The motion judge then turned to the position of CCFL. She concluded that under the terms of its loan agreement with Med-Chem, CCFL was entitled to advances from Med-Chem for expenses incurred in defending the action.
[13] Finally, after receiving further submissions on the issue, the motion judge outlined the appropriate process to be used in determining the reasonableness of the expenses for which advancement is sought, and of future accounts that will be incurred by the respondents as the action continues. She decided that in both cases, payment should be first made by Med-Chem, which shall then have the right to have those accounts assessed pursuant to the Solicitors' Act, R.S.O. 1990, c. S.15.
Analysis
[14] The appellant does not dispute its obligation to indemnify the respondents at the conclusion of the litigation. However, it contests any obligation to reimburse the respondents by way of advancement, that is, to reimburse them from time to time for litigation expenses incurred as the action progresses. It raises three issues on this appeal: (a) whether it is compelled by By-law No. 12 and s. 136 of the OBCA to make advances to the former directors; (b) whether it is compelled by its loan agreement to indemnify CCFL from time to time for legal fees incurred by CCFL in defending the action; and (c) whether the motion judge erred in requiring payment prior to assessment pursuant to the Solicitors' Act.
First issue: Advancement to the former directors
[15] On October 29, 1996, in anticipation of the company's initial public offering, Med-Chem enacted By-law No. 12. Article 6.3 of the by-law provides for indemnification by the company of designated persons who incur legal expenses because of their association with the company: [page773]
6.3 INDEMNITY
Subject to the limitations contained in the Act, the Corporation shall indemnify a director and officer of the Corporation, a former director or officer, or a person who acts or acted at the Corporation's request as a director or officer of a body corporate of which the Corporation is or was a shareholder or creditor (or a person who undertakes or has undertaken any liability on behalf of the Corporation or any such body corporate) and his heirs and legal representatives, against all damages, costs, charges and expenses, including an amount paid to settle an action or satisfy a judgment, reasonably incurred by him in respect of any civil, criminal or administrative action or proceeding to which he is made a party by reason of being or having been a director or officer of the Corporation or such body corporate, if (a) he acted honestly and in good faith with a view to the best interests of the Corporation or such body corporate; and (b) in the case of a criminal or administrative action or proceeding that is enforced by a monetary penalty, he had reasonable grounds for believing that his conduct was lawful. The Corporation shall also indemnify such person in such other circumstances as the Act permits or requires. Nothing in this By-law shall limit the right of any person entitled to indemnity to claim indemnity apart from the provisions of this By-law.
[16] Section 1.1(a)(i) of the by-law defines "Act" to be the OBCA as from time to time amended. The relevant sections of the OBCA in effect at the time of the motion are the following:
136(1) A corporation may indemnify a director or officer of the corporation, a former director or officer of the corporation or another individual who acts or acted at the corporation's request as a director or officer, or an individual acting in a similar capacity, of another entity, against all costs, charges and expenses, including an amount paid to settle an action or satisfy a judgment, reasonably incurred by the individual in respect of any civil, criminal, administrative, investigative or other proceeding in which the individual is involved because of that association with the corporation or other entity.
Advance of costs
(2) A corporation may advance money to a director, officer or other individual for the costs, charges and expenses of a proceeding referred to in subsection (1), but the individual shall repay the money if the individual does not fulfil the conditions set out in subsection (3).
Limitation
(3) A corporation shall not indemnify an individual under subsection (1) unless the individual acted honestly and in good faith with a view to the best interests of the corporation or, as the case may be, to the best interests of the other entity for which the individual acted as a director or officer or in a similar capacity at the corporation's request. . . . . .
Derivative actions
(4.1) A corporation may, with the approval of a court, indemnify an individual referred to in subsection (1), or advance moneys under subsection (2), in respect of an action by or on behalf of the corporation or other entity to obtain a judgment in its favour, to which the individual is made a party [page774] because of the individual's association with the corporation or other entity as described in subsection (1), against all costs, charges and expenses reasonably incurred by the individual in connection with such action, if the individual fulfils the conditions set out in subsection (3). . . . . .
Application to court
(5) A corporation or a person referred to in subsection (1) may apply to the court for an order approving an indemnity under this section and the court may so order and make any further order it thinks fit.
[17] The appellant makes three arguments in contesting its obligation to pay advances to the former directors.
[18] First, it argues that the obligation to advance (which it disputes) is different from the obligation to indemnify (which it acknowledges). Since By-law No. 12 makes no reference to any obligation to advance, Med-Chem argues that it has no such obligation.
[19] I do not agree. Section 6.3 of By-law No. 12 clearly requires Med-Chem to indemnify the eligible individuals in all those circumstances in which the OBCA allows indemnification. The by-law makes mandatory what the OBCA permits.
[20] Section 136(2) of the OBCA allows the corporation (subject to a specified repayment condition) to pay advances of the legal expenses that the corporation may indemnify under s. 136(1). More importantly, s. 136(4.1), under which these proceedings are brought, allows the corporation to do the same (with the court's approval), if the action is brought by or on behalf of the corporation itself and the individuals are made parties to it by virtue of their association with the corporation. Thus, s. 136 provides for advancement of the same legal costs, charges and expenses that may be indemnified by the corporation. In short, the legislature has made advancement a part of the statutory indemnification scheme, recognizing the reality that requiring an individual to fund his or her costs of litigation until its conclusion before being provided with indemnification would seriously impair the objective of indemnification itself. As described by the Supreme Court of Canada in Blair v. Consolidated Enfield Corp., 1995 CanLII 76 (SCC), [1995] 4 S.C.R. 5, [1995] S.C.J. No. 29, at para. 74: "Indemnification is geared to encourage responsible behaviour yet still permit enough leeway to attract strong candidates to directorships and consequently foster entrepreneurism."
[21] When s. 136 of the OBCA is read together with By-law No. 12, the answer to the appellant's first argument is clear. The OBCA permits a corporation to advance those legal expenses that it may indemnify. The by-law makes this mandatory. The appellant must advance the legal expenses that it must [page775] later indemnify, subject only to the repayment condition in s. 136(3) and the court's approval required under s. 136(4.1).
[22] The appellant's second argument is that the advancement provisions of s. 136(2) and s. 136(4.1) do not extend to former directors, since, unlike s. 136(1), former directors are not expressly referred to as eligible recipients.
[23] I agree with the motion judge that the answer to this argument is one of statutory interpretation. Section 136(1) provides for indemnification to directors or officers, former directors or former officers, or other individuals acting at the corporation's request for another entity as directors or officers, or in a similar capacity. Under s. 136(2), those who qualify for advances are directors or officers, or any "other individual" being indemnified for legal expenses under s. 136(1). The category of "other individual" is a broad one, designed to encompass in addition to directors and officers those who are listed in s. 136(1). That includes former directors. It is simply legislative shorthand.
[24] The appellant's third argument is that the motion judge erred in concluding that the former directors fulfilled the conditions set out in s. 136(3) and that, in all the circumstances, she should exercise her discretion under s. 136(4.1) to approve advances to them.
[25] Section 136(3) provides that an individual who does not act honestly in good faith is disqualified from being indemnified. Blair says that the policy objective behind indemnification requires that individuals be assumed to act in good faith unless proven otherwise. The motion judge found that, on the evidence before her, the mala fides of the former directors had not been established. She went further and concluded that, given their conduct as described in the appellant's own material, and the court's previous approval of indemnification for them in the action brought by Dr. Alvi personally, the former directors have sufficiently established the bona fides of their conduct. There was ample evidence before the motion judge to sustain both these conclusions and there is no basis for this court to interfere with them.
[26] In deciding to exercise her discretion under s. 136(4.1) to approve these advances, the motion judge considered a number of factors, all of which are relevant and reasonable in my view. However, the appellant says that she should have considered (i) whether there was proof of an inability to pay for the litigation without advances; (ii) the presence of insurance to fund them; and (iii) the respondents' delay in seeking the advances.
[27] There is no merit to these submissions. Neither By-law No. 12, nor s. 136 of the OBCA, requires an inability to pay or the presence of insurance coverage. Nor does common sense. At [page776] an early stage of clearly complex litigation, any meaningful assessment of a party's ability to pay would be almost impossible. And indemnity, which is for the benefit of the designated individuals, ought not to be contingent on the existence of insurance, which is for the benefit of the company and which can be changed or cancelled by it. Finally, on the facts of this case, the delay by the respondents in seeking advances pales in comparison with the appellant's own delay in commencing the action itself. There is no basis to interfere with this exercise of discretion by the motion judge.
Second issue: Indemnification of CCFL
[28] Section 3.8 of the loan agreement between CCFL and the appellant reads as follows:
3.8 Expenses and Legal Fees. The Borrower [Med-Chem] agrees to pay upon demand all of the Lender's [CCFL] and its agents' reasonable costs relating to the implementation and/or completion of the transaction herein contemplated, and to all other matters for which such costs may be incurred for so long as this Agreement shall be contemplated or in effect between the Lender and the Borrower. Without limiting the generality of the foregoing, the Borrower agrees to pay upon demand: . . . (b) the reasonable legal fees and disbursements of any counsel retained in connection with advising the Lender generally on the subject matter of the transaction contemplated herein and the actions of the Lender hereunder and in connection with the protection and/or enforcement of any rights or remedies of the Lender hereunder . . . Until paid all such amounts shall be deemed to be Advances under the Credit.
[29] The appellant argues that the legal costs for which CCFL seeks indemnity fall outside this provision because they do not relate to the implementation or completion of the loan transaction and arose after the loan had been repaid.
[30] The motion judge disagreed with this reading of s. 3.8. She found that the legal expenses were demanded of CCFL by the appellant to defend the activities of the lender during the course of the loan transaction that the appellant attacks in the litigation. She reasoned that since there is no provision in s. 3.8 specifying that the obligations it provides for come to an end with repayment of the loan, there is no basis for the appellant's complaint. I agree. This argument must fail.
[31] The appellant also says that CCFL Mezzanine is not entitled to the benefits of s. 6.3 since it is not the lender, but the general partner of the lender. I agree, and would not read the order appealed from to provide for that entitlement. I think it is clear, however, that this distinction has no real practical effect since Mr. Kinlough, CCFL and CCFL Mezzazine all have the same counsel providing the same services to defend the action, [page777] all of which will be subject to indemnification and advancement in favour of two of these three parties.
The third issue: The process to be followed
[32] The final issue is whether the motion judge erred in providing for a process that requires the advances to be paid before being assessed for reasonableness under the Solicitors' Act.
[33] In my view, the motion judge was well within her discretion and did not err in requiring that the advances she ordered be paid prior to assessment. She received full submissions on the issue before reaching this conclusion. She did so for the reasons she articulated at para. 12 of her supplementary reasons, with which I agree:
I accept that the delay that in this case would be entitled in requiring an assessment before payment is contrary to the aim of an advance. If the legal expenses are reduced on assessment, Med-Chem will be entitled to a refund. In this case, there is far greater risk to the indemnified parties of non-payment if payment is delayed by an assessment than there is that the indemnified parties would fail to pay any required refund. Moreover, I am prima facie satisfied as to the reasonableness of the portion of the expenses incurred to date that I am ordering be paid before an assessment.
[34] The appeal is therefore dismissed. Since this means that the respondents are entitled to recover the legal costs that they incur in defending this action, there is no need for this court to make a specific order as to costs of this appeal.
Appeal dismissed.