COURT OF APPEAL FOR ONTARIO
CITATION: König v. Hobza, 2014 ONCA 691
DATE: 20141009
DOCKET: C57156
Hoy A.C.J.O., Gillese and Lauwers JJ.A.
BETWEEN
Klaus-Peter König
Plaintiff (Respondent)
and
Antonin Hobza, John Douglas Laine, Kim H. Dobson, John Anthony Chisholm also known as Jack Chisholm, TJK Enterprises Limited and 1669051 Nova Scotia Limited
Defendants (Appellants)
Sarit E. Batner and Justin H. Nasseri, for the appellants
Ronald Flom, for the respondent
Heard: July 18, 2014
On appeal from the judgment of Justice Laurence A. Pattillo of the Superior Court of Justice, dated May 10, 2013, with reasons reported at 2013 ONSC 1060, and from the costs judgment, dated November 20, 2013, with reasons reported at 2013 ONSC 5531.
Hoy A.C.J.O.:
I. INTRODUCTION
[1] The respondent, Klaus-Peter König, was a silent investor in the successful 1669051 Nova Scotia Limited, formerly East West Plastics & Electric Products Limited (“East West”). He was the only shareholder of East West not involved in its management and operation.
[2] Among other things, the respondent claimed that Antonin Hobza, John Douglas Laine and Kim H. Dobson, and Jack Chisholm (the “Managing Directors”) – as officers and directors of East West and, through TJK Enterprises Limited (“TJK”), shareholders – awarded themselves excessive compensation over a period of 22 years. The respondent argued that this conduct breached his reasonable expectations and warranted an oppression remedy.
[3] The trial judge agreed. He found the appellants East West, Hobza, Dobson and Laine (but not Chisholm, who had ceased to be involved with East West in November of 1997) jointly and severally liable for damages in the amount of $250,000 and prejudgment interest in the amount of $49,793.83. The trial judge also concluded that the appellants’ conduct warranted costs on a substantial indemnity scale, and awarded costs on that scale in the amount of $413,000, inclusive of disbursements and taxes.
[4] The appellants’ main arguments on appeal are that the trial judge erred: (1) by fixing a precise amount as the total fair market value compensation for the Managing Directors in each year, in the face of what they say was unanimous expert evidence, which the trial judge accepted, that there is always a range of fair market compensation, and by failing to provide a basis or methodology for doing so; and (2) by failing to calculate the over-compensation on a net basis over the entire 22-year period at issue. Had the trial judge properly accepted that compensation at any point within the range was fair, and considered the Managing Directors’ compensation on a net basis over the entire 22-year period, he would have concluded that the appellants had been overpaid by a much lesser amount. Indeed, when properly averaged over the full 22-year period at issue, the excess pay would have been so little that it would not have “unfairly prejudiced or unfairly disregarded” the respondent’s interests. Alternatively, it would have resulted in a much reduced damages award.
[5] The appellants also argue that the trial judge erred in finding that the appellants’ conduct regarding financial disclosure was oppressive and in fixing costs on a substantial indemnity scale. Finally, they submit that if costs were properly assessed on a partial indemnity scale, judgment would not be more favourable than the appellants’ Rule 49[^1] offer to settle the action for $300,000, inclusive of interest, plus partial indemnity costs. Accordingly this court must give effect to the cost consequences of Rule 49.10.
[6] For the reasons that follow, I conclude that the trial judge erred by not calculating the Managing Directors’ over-compensation on a net basis over the entire 22-year period at issue and would accordingly reduce damages to $187,453.51, and prejudgement interest thereon to $37,336.12. I would not interfere with the trial judge’s award of costs on a substantial indemnity scale. However, because I would reduce the quantum of damages, I would return the questions of the quantum of those costs and the cost consequences of Rule 49.10 to the trial judge for reconsideration. I would otherwise dismiss the appeal.
[7] Below, I first outline the background of the respondent’s claim, the trial judge’s principle findings and the process by which the trial judge determined what fair market compensation would have been. I then address the appellants’ arguments in turn.
II. BACKGROUND
[8] The respondent König lives in Germany. He and Hobza became friends in 1978, when Hobza worked in Germany at the respondent’s father’s company for a few months. After Hobza returned to Canada, they remained in touch and the respondent expressed interest in being involved in any business that Hobza might establish.
[9] In 1985, Hobza, Dobson, Laine and Chisholm founded East West, a sign supply distribution company. They held their shares in East West through TJK.
[10] The respondent and Hobza agreed that the respondent would invest $100,000 in East West and be entitled to a 10% interest in it. Hobza told the respondent that when East West made a profit, it would remain in the company or the respondent would receive a 10% share. The respondent asked that his name not appear on any papers showing his investment: the respondent’s father had friends at East West’s competitor. Accordingly, TJK held the respondent’s shares in trust for him. Dobson, Laine and Chisolm agreed to the respondent’s investment in East West.
[11] Although there had been no discussion of the respondent’s money being a loan, the $100,000 he provided to Hobza was provided to East West as a shareholder loan – as were the lesser amounts advanced by the Managing Directors. The Managing Directors also guaranteed the payment of the operating loan in the range of $400,000 to $500,000 made to East West by its bank.
[12] East West never held a shareholders’ meeting (until the sale of the business in 2007) or a formal directors’ meeting. From the outset, Hobza, Dobson, Laine and (until he left East West in November of 1997) Chisholm ran East West. They spoke with each other daily and agreed on all major decisions.
[13] The Managing Directors set their compensation yearly, in arrears, following the end of the fiscal year. In doing so, they considered revenues and expenses in the prior year, as well as East West’s tax position and bank covenants. By agreement, each received the same amount of compensation in each year. Total actual compensation paid ranged from $40,000 in 1986 ($10,000 to each of Dobza, Hobson, Laine and Chisholm) to a high of $1,650,000 in 2006 ($550,000 to each of Hobza, Dobson and Laine). As well, during the first few years of operation, East West repaid the shareholder loans advanced by the Managing Directors.
[14] In 1988, the Managing Directors signed a directors’ resolution (the “1988 Resolution”) declaring a bonus payable in the amount required to reduce the active business income of East West to $200,000 for the then fiscal year and all subsequent fiscal years. This ensured that East West would be taxed at the lower, small business rate of taxation.
[15] From 1986 to 1990, and in the 2003, 2006 and 2007 fiscal years, East West’s financial statements were audited. In the remaining years, its accountants provided a review engagement report only.
[16] From 1986 to 1992, East West’s financial statements disclosed the total compensation paid to the Managing Directors as a line item. Beginning with the year ended November 30, 1993, East West adopted a different practice, to avoid disclosing sensitive information to suppliers who requested copies of the financial statements. For the years ended November 30, 1993 and November 30, 1997, and for the three-month period ended February 28, 1998, compensation paid to the Managing Directors was instead detailed on a separate schedule, entitled Statement of Warehouse, Selling and Administrative Expenses, and not broken out in the financial statements. For the fiscal years ended November 30 1994, 1995 and 1996, and fiscal years ended February 28, 1999, 2000 and 2001, a portion of the Managing Directors’ compensation was set out in the financial statements, and the balance was disclosed in the Statement of Warehouse, Selling and Administrative Expenses. For the fiscal years ended February 28, 2002 to 2006 (February 29 in 2004), the entirety of the compensation was set out in the financial statements.
[17] The respondent received the separate Statement of Warehouse, Selling and Administrative Expenses only for the fiscal years ended February 28, 2001 and 2002. The trial judge found that the respondent only received financial information concerning the full compensation received by the Managing Directors for the period from 1993 to December 2000.
[18] In November of 1997, Chisholm left East West, and East West purchased his interest in TJK and East West. As a result, the remaining shareholders’ percentage interests in East West increased – in the case of the respondent, from 10% to 12.25%.
[19] At para. 45 of his reasons, the trial judge found that:
[A]lmost from the time [the respondent] first received East West’s financial information, he asked questions of Hobza concerning the nature of his interest in East West and monies paid by East West to the Managing Directors. Further, as time went by and East West became more profitable, in addition to questions about what the Managing Directors were being paid, [the respondent] questioned why the profits of East West were not being distributed to the shareholders.
[20] The respondent learned in 1990 that his $100,000 investment was being characterized as a loan, and not equity, but that he was nonetheless entitled to a 10% interest in East West. And, while some information was provided by East West’s accountant in 2000 regarding compensation in 1999 and 2000, it was not until March 2007 that East West’s auditors provided the respondent with a breakdown of the total compensation paid by East West to the Managing Directors from 1986 to 2006. In response to his queries about why no dividends had been declared, the respondent was always told that East West’s bank would not permit it to pay dividends.[^2]
[21] In early 2001, the respondent requested that East West repay his $100,000 loan, and by March 2002 it was repaid, without interest. The respondent also asked to transfer his shares to his company, König GmbH. His request was refused.
[22] In late 2004, the respondent took issue with the level of compensation paid to the Managing Directors in the year ended February 29, 2004. The response was abrupt: he was advised that East West was “a private company” and it was “not [his] business”. The dialogue did not end. As noted above, it was not until March 2007 that East West’s auditors provided the respondent with a complete breakdown of the total compensation paid by East West to the Managing Directors from 1986 to 2006.
[23] East West was successful. Its revenues and gross profit grew in every year except 1991. Between 1985 and 2007, it expanded from three branches and 13 employees (including the Managing Directors) to six branches and 130 employees. For the fiscal year ended February 28, 2007, sales were approximately $50.6 million, gross profit was $13,953,136 and net after-tax income was $1,544,125.
[24] By early 2007, the parties had retained litigation counsel.
[25] In June of 2007, East West sold its business to an arm’s length purchaser. The respondent received approximately $1.5 million in respect of his 12.25% interest. As a condition of the sale, Laine entered into an employment contract with the purchaser to be its president at an annual base salary of $170,000 plus a discretionary bonus of up to 50% of base salary.
[26] The respondent commenced this action against the appellants in 2008. He invoked the oppression remedy provisions of East West’s incorporating statute, the Nova Scotia Companies Act, R.S.N.S. 1989, c. 81 (the “Act”),[^3] alleging that East West’s profits were stripped to the benefit of the Managing Directors and that such conduct was oppressive, unfairly prejudicial and unfairly disregarded the respondent’s interests as a shareholder of East West. He also alleged breach of trust, third-party breach of trust based on knowing receipt, and breach of fiduciary duty.
III. THE TRIAL JUDGE’S KEY FINDINGS
[27] The trial judge provided thorough reasons, 227 paragraphs in length. Here, by way of overview, I set out the trial judge’s key findings. Further below, I provide detail about how the trial judge determined fair market compensation for the Managing Directors.
[28] The trial judge dismissed the respondent’s claims in breach of trust, third-party liability for breach of trust, and breach of fiduciary duty. However, he agreed that two aspects of the appellants’ conduct – the lack of financial disclosure and the excessive compensation – warranted an oppression remedy.
[29] On financial disclosure, the trial judge found that “from the outset of the relationship through to 2007, there was a pattern of non-disclosure or worse, wrong information by East West and Hobza towards [the respondent] as a shareholder” (para. 87). There was no issue concerning financial disclosure from 1986 to 1992: the financial statements for those years included a breakdown of the compensation paid to the Managing Directors (para. 118). However, the failure to disclose the Managing Directors’ compensation to the respondent for the years between 1993 and 2000 constituted a breach of the respondent’s reasonable expectations as a shareholder by East West and the Managing Directors that was oppressive, unfairly prejudicial or unfairly disregarded the respondent’s interests as a shareholder (para. 121).
[30] With respect to excessive compensation, the trial judge found that it was a reasonable expectation that the Managing Directors be paid a fair salary and bonus for the work they did, and that any net income remaining would either be retained in the corporation to be used for corporate purposes or paid to shareholders by way of dividend (para. 123). In the following chart (which refers to market survey evidence regarding executive compensation compiled by executive compensation experts Morneau Shepell, explained below) the trial judge set out what he found the total fair market value compensation for the Managing Directors in each of the years in question to be as follows:
| East West Fiscal Year | Total Actual Compensation ($) | Morneau Shepell 50% | Morneau Shepell 75% | Total Fair Market Compensation ($) |
|---|---|---|---|---|
| 1986 | 40,000 | 283,562 | 389,661 | 300,000 |
| 1987 | 200,000 | 271,414 | 401,884 | 325,000 |
| 1988 | 385,600 | 330,000 | 410,000 | 350,000 |
| 1989 | 192,000 | 342,215 | 423,941 | 360,000 |
| 1990 | 302,000 | 337,582 | 398,388 | 365,000 |
| 1991 | 240,000 | 351,506 | 416,809 | 375,000 |
| 1992 | 270,000 | 418,056 | 502,712 | 425,000 |
| 1993 | 312,000 | 399,568 | 481,421 | 425,000 |
| 1994 | 599,600 | 407,919 | 486,522 | 450,000 |
| 1995 | 672,000 | 431,107 | 521,474 | 500,000 |
| 1996 | 502,000 | 600,850 | 773,025 | 625,000 |
| 1997 | 556,000 | 542,300 | 653,250 | 650,000 |
| 1998 (3 months) | 129,000 | 98,856 | 118,682 | 110,000 |
| 1999 | 980,500 | 414,475 | 514,725 | 500,000 |
| 2000 | 875,000 | 513,025 | 623,275 | 550,000 |
| 2001 | 743,700 | 525,475 | 734,050 | 625,000 |
| 2002 | 525,000 | 432,525 | 605,475 | 625,000 |
| 2003 | 630,000 | 552,625 | 767,333 | 650,000 |
| 2004 | 1,200,000 | 512,625 | 688,067 | 675,000 |
| 2005 | 1,500,000 | 559,800 | 703,550 | 700,000 |
| 2006 | 1,650,000 | 522,875 | 714,600 | 700,000 |
| 2007 | 807,150 | 564,700 | 802,267 | 750,000 |
| Totals | 13,311,550 | 11,035,000 |
[31] On a net basis, the total amount paid by East West to the Managing Directors from 1986 to 2007 exceeded the total fair market compensation for the period by $2,276,550 (para. 165). In the trial judge’s view, whether this constituted a breach of the respondent’s reasonable expectations and was oppressive, unfairly prejudicial or unfairly disregarded his interests, should be determined on a net basis, taking into account the deficiencies in compensation received as well as the excesses over the 22-year period at issue, consistent with the parties’ approach (paras. 168 and 171).
[32] On the evidence, the trial judge determined that the claim should be broken into two periods: 1986-1992 and 1993-2007 (para. 172).
[33] He concluded that the Managing Directors’ actions in setting compensation in the period between 1986 and 1992 was not a breach of the respondent’s reasonable expectations, and was not oppressive or unfairly prejudicial, and did not unfairly disregard his rights as a shareholder (para. 173). First, their compensation was only in excess of what was reasonable in 1988, and then only by $35,600 (para. 175). On a net basis for 1986-1992, the Managing Directors received significantly less than the fair market compensation over that period. Second, the remuneration that the Managing Directors received was clearly set out in East West’s financial statements, which the respondent received (para. 176). Finally, the oppression remedy provisions in the Act did not come into force until July 1991, and its provisions are not retrospective (para. 177).
[34] However, the trial judge concluded that the excess compensation the Managing Directors received over the period between 1993 and 2007 was a breach of the respondent’s reasonable expectations as a shareholder and was unfairly prejudicial and unfairly disregarded the respondent’s interests as a shareholder (para. 186). The trial judge found that it was significantly in excess of what was fair and reasonable during the period (para. 180). And because the Managing Directors were shareholders, when they paid themselves excess compensation, it effectively amounted to a dividend (para. 182). The sole criteria they considered were reducing East West’s tax rate and East West’s covenants with its bank. No consideration was given to whether their compensation was fair and reasonable for the work they were doing (para. 183).
[35] The trial judge indicated that he accepted the methodology of Steve Ranot, a partner with Marmer Penner Inc., business valuators and litigation accountants, for calculating damages (para. 194). On that methodology, the after-tax amount to East West of each excess or deficit in compensation for each year over the 22-year period should be determined using the applicable tax rate. The respondent would be entitled to 10% of the net amount overpaid up to November 30, 1997, when Chisholm left, and 12.25% thereafter, either in the form of dividends or as his share of retained earnings (para. 192).
[36] However, the trial judge applied Mr. Ranot’s methodology with respect to the last 15 years of the 22-year period, and used 12.25% for the entire period, on the basis that the net after-tax amount for the five years prior to 1997 (Chisholm’s departure) results in a small deficit. On that basis, he concluded that the respondent’s damages were $250,000 (para. 195).
[37] The trial judge found East West, Hobza, Dobson and Laine jointly and severally liable for the damages. Chisholm, however, was not liable: during the five years of the 15 year period between 1993 and 2007 that Chisholm was still with East West, the Managing Directors’ conduct in setting compensation was not oppressive or unfairly prejudicial (para. 196). On a net basis, total compensation for that five-year period was less than the total fair market compensation for the same period (para. 197).
IV. HOW THE TRIAL JUDGE DETERMINED TOTAL FAIR MARKET COMPENSATION FOR THE MANAGING DIRECTORS
[38] The appellants and the respondent called executive compensation experts to establish whether the amounts that East West paid the Managing Directors constituted fair market compensation.
[39] While the appellants only take issue with the final step in the trial judge’s determination of fair market compensation – fixing specific amounts rather than accepting that anything within the 50th to 75th percentile range of the Morneau Shepell market survey was fair market compensation – an understanding of the process undertaken by the trial judge sets the stage for this final step in his analysis. It also demonstrates that the trial judge considered the experts’ evidence in a careful and balanced fashion.
[40] The parties’ experts compiled market survey evidence about what organizations paid individuals in comparable positions. The trial judge preferred the market survey evidence of the respondent’s expert, Michel Dubé of Morneau Shepell, over that of the Managing Directors’ expert: Mr. Dubé specifically compiled the survey data for each year utilizing companies that had similar sales to East West for each year in question (para. 153).
[41] The trial judge considered whether long-term incentive programs (“LTIPs”) should be included in determining total compensation. Including LTIPs in the comparators would justify higher cash compensation for the Managing Directors. He accepted the evidence of Mr. Dubé over that of the appellants’ experts, Paul Gryglewicz and David Crane, that it was not appropriate to include LTIPs in determining total compensation for the Managing Directors.
[42] The trial judge rejected the evidence of Mr. Ranot that Dobson and Chisholm should be classified as middle management for the purpose of determining compensation. He concluded that all of the Managing Directors should be treated as holding executive level positions (paras. 155 and 156).
[43] He also rejected the evidence of Mr. Ranot that, based on the compensation that the purchaser was to pay Laine, which fell between the 25th and 50th percentiles, an average of the 25th and 50th percentiles should be used to determine fair market value compensation. The trial judge reasoned that Laine’s compensation is only one data point and not indicative of the market. Moreover, his compensation did not arise out of a traditional employee/employer negotiation (paras. 150, 159-60).
[44] Instead, the trial judge accepted the evidence of the appellant’s expert, Mr. Crane, that fair market value compensation for the Managing Directors should fall somewhere between the 50th and 75 percentile of Morneau Shepell’s survey results for each year (para. 161).
[45] The trial judge then made the determination with which the appellants take issue. He wrote that what, within that range, constitutes fair market compensation will depend in part on the internal equities of East West, and outlined factors (discussed below) that he considered in fixing a point within that range.
V. ISSUES ON APPEAL
(1) Did the trial judge err by fixing fair market compensation for each year?
[46] The appellants argue that the trial judge erred by generating precise figures for fair market compensation for each year, instead of following what the appellants say was the unanimous opinion of the experts, which he accepted, that there is always a range for fair market compensation. They say that as long as the Managing Directors’ compensation was at some point within the 50th to 75th percentile in Morneau Shepell’s market survey – the range and survey accepted by the trial judge – it was reasonable. Further, they say the trial judge compounded his error in principle by failing to provide any basis or methodology for his determination of what fair and reasonable compensation would have been.
[47] I reject both arguments.
[48] As to the first argument, it cannot fairly be said that the experts unanimously testified that compensation is reasonable simply if it falls anywhere within the identified percentile range of the accepted market survey results for the benchmarked position (in this case, the Morneau Shepell survey utilized by Mr. Dubé) for a year. The trial judge’s approach of treating the range merely as a starting point in determining fair compensation is supported by the record.
[49] Mr. Dubé testified that market is “by far” not the only factor to consider in considering appropriate compensation for an executive. “Internal equity” is just as important. And Mr. Ranot – whom the trial judge accepted as an expert in business valuation, noting that business valuation included the assessment of fair market compensation for executives – similarly testified that the market survey results are only one factor in assessing the appropriateness of executive compensation.
[50] The trial judge had evidence before him as to what “internal equity” meant, and what other relevant factors were.
[51] The trial judge accepted Mr. Ranot’s evidence on the methodology for the calculation of damages. Given that, the following exchange in the cross-examination of Mr. Ranot, coupled with Mr. Dubé’s and Mr. Ranot’s evidence referred to above, is in my view dispositive of the appellants’ first argument:
Q. And will you agree with me that the concept of market compensation and executive compensation is just really not that precise?
A. Yes.
Q. And that there is a broad range of what is fair and appropriate in any give case for the compensation of an executive?
A. Yes, there’s a range. We tried to take the midpoint of that range to arrive at a conclusion.
Q. I understand that, but in taking the midpoint of the range what you are saying is to the extent the directors in this case had a different place in the range, they are wronged and the excess is damages? That’s your opinion, right?
A. Yes. [Emphasis added.]
[52] In other words, the trial judge had before him expert evidence that he should not simply accept a range and should make a specific determination of fair market compensation.
[53] Nor do I accept that the trial judge provided no analysis as to how he reached the numbers within the 50th and 75th percentile of Morneau Shepell’s survey results for each year that he did, and that his determinations accordingly cannot stand. He did so at paras. 161-163 of his reasons:
Where exactly the compensation will fall in that range for each year will depend in part on the internal equities in respect of East West which include the financial success of East West compared to the year prior and overall and the compensation paid to the Managing Directors in the prior year. I have also had regard to the compensation information for East West’s senior employees for the years 2004 to 2007 as contained in Exhibit 17 [the answer to undertakings].
In considering prior years’ compensation, it is apparent from the Morneau Shepell survey results that in some years the compensation numbers are less than the prior year. In such situations, where East West’s gross profit increased over the prior year, it is my view that the Managing Directors’ compensation should not fall below that of the previous year.
Further, while total compensation paid by East West to the Managing Directors will decrease beginning in 1998 as a result of Chisholm’s departure, in my view it does not mean that it should increase by an amount equal to Chisholm’s full compensation. The remaining three Managing Directors are entitled to some additional compensation over and above what they would otherwise have been entitled to given that they assumed Chisholm’s responsibilities. While Laine assumed many of Chisholm’s responsibilities, the increase is split equally between the three Managing Directors given their agreement.
[54] All agreed that setting executive compensation is a complex and imprecise exercise: as Mr. Ranot testified, it is an art and not a science. In my view, the trial judge provided satisfactory reasons as to how, in conducting this imprecise exercise, he arrived at specific amounts for each year.
[55] As I note below, this is not a case of a trial judge supplanting directors’ business judgment as to what, within a range, was fair and reasonable executive compensation. Here, effectively no business judgement was exercised. The trial judge engaged in the exercise that the Managing Directors had failed to undertake.
(2) Did the trial judge err by not approaching the calculations on a net basis over the full 22-year period?
[56] As the trial judge acknowledged at para. 124 of his reasons, “the central issue in [the] action” was whether the compensation paid to the Managing Directors from 1986 to 2007 was fair and reasonable. The respondent and his expert, Mr. Ranot, calculated the respondent’s claim on a net basis over the entire 22-year period. I agree with the appellants that the trial judge erred in principle by not calculating whether, and by what amount, the Managing Directors were over-compensated by reference to the entire 22-year period at issue. By not doing so, the trial judge failed to consider the payments in later years in light of the under-compensation and give the Managing Directors credit for the amount by which they were under-compensated in East West’s early years, and as a result, overstated the respondent’s damages.
[57] East West began as a small start-up. Its Managing Directors were under-compensated in its early years. Their higher rates of compensation when East West matured would in part effectively have recompensed them for lack of compensation during the early years.
[58] The trial judge appreciated this. Several passages in his reasons highlight the importance of calculating excess compensation on a net basis over the full 22-year period:
[168] The remuneration of East West’s Managing Directors was tied to the companies’ cash flow. As can be seen from [the compensation table], in the early years of East West’s operation, reduced revenues resulted in compensation below fair market. The compensation received was what East West could afford at the time. Even as revenues grew, there were years when the Managing Directors’ compensation was below what I have concluded was the fair market compensation for that year. Where, as here, the company was otherwise well run and profitable year after year, in my view it is more appropriate to consider the issue on a net basis taking into account the deficiencies in compensation received as well as the excesses.
[175] [O]n a net basis, for the years 1986 to 1992 the Managing Directors received significantly less compensation than the fair market compensation over the same period.
[185] [B]y approaching the issue of oppression in the way in which I have, I have taken into account the years the Managing Director’s compensation was below fair market.
[192] Mr. Ranot presented [the respondent’s] damage claim on a cumulative or net basis for the entire 22 year period.
[194] While I do not accept Mr. Ranot’s determination of fair market compensation, I am of the view that his methodology in calculating damages is appropriate and should be followed in this case.
[59] And Mr. Ranot explained that his methodology for calculating damages, which the trial judge indicated that he accepted, involved “making up for the bad years”. (TR, vol 1, p. 452).
[60] Despite this, the trial judge ultimately calculated damages only over the 15-year period from 1993 to 2007, excluding the six-year period after East West was founded during which the Managing Directors were significantly under-compensated.
[61] Respectfully, the trial judge’s reasons in this one respect are flawed. Essentially, he concluded that the Managing Directors’ conduct in relation to compensation during that period did not breach the respondent’s reasonable expectations – they were not over-compensated during that period and their compensation was disclosed – and was not oppressive or unfairly prejudicial, and did not unfairly disregard the respondent’s interests as a shareholder. Moreover, he reasoned, the oppression remedy provisions of the Act did not come into force until July 1991 and were not retrospective.
[62] Focussing on whether the Managing Directors’ conduct in relation to compensation during the six-year period after East West was founded supports an oppression remedy is a red herring. This reasoning ignores the importance of assessing the respondent’s reasonable expectations, and the Managing Directors’ compensation, in the period from 1993 to 2007 in light of the Managing Directors’ acknowledged under-compensation during the prior period. It amounts to an error in principle. Accordingly, in my view, the trial judge’s damages calculation cannot stand.
[63] Using the trial judge’s methodology for calculating damages (described at paras. 35 and 36 above), but crediting the Managing Directors for their under-compensation prior to 1993, I would reduce the damages to $187,453.51. In doing so, I use the trial judge’s determination (in the chart at para. 164 of his reasons, reproduced at para. 30 above) of compensation paid and fair market compensation during each of the 22 years, and employ the tax rates used by him in Schedule A of his reasons to determine the after tax amount of the deficit or excess in compensation paid in each such year. My calculation of this amount is reproduced at Schedule A of these reasons. It aligns with that included in Schedule D of the appellants’ factum.
[64] The fact that I arrive at a lesser amount than the trial judge does not warrant disturbing his conclusion that the payment of the excess compensation breached the respondent’s reasonable expectations, and unfairly prejudiced or unfairly disregarded the respondent’s interests. Indeed, had damages been assessed in the manner that the appellants argue they should have, I would still conclude that the Managing Directors had breached the respondent’s reasonable expectations and that this breach justified an oppression remedy.
[65] Both quantum and process are relevant. The trial judge clearly found that in fixing their compensation, the Managing Directors did not consider whether it was fair and reasonable for the work done. In other words, they did not consider the respondent’s interests. This is not a case of a trial judge supplanting directors’ business judgment as to what was fair and reasonable executive compensation for the work done. Here, effectively no business judgement was exercised.
(3) Did the trial judge err in finding that the appellants’ failure to make financial disclosure warranted an oppression remedy, or in awarding substantial indemnity costs?
[66] The appellants focus on whether their conduct regarding financial disclosure was oppressive because that conduct played a role in the trial judge’s subsequent decision to fix costs on a substantial indemnity scale. Because of the interplay between these two final issues, I consider them together.
[67] As noted above, the trial judge found that the failure to disclose the Managing Directors’ compensation to the respondent for the period between 1993 and 2000 constituted a breach of the respondent’s reasonable expectations as a shareholder by East West that was oppressive, unfairly prejudicial or unfairly disregarded the respondent’s interests as a shareholder.
[68] The appellants advance two main arguments about the characterization of the appellants’ non-disclosure.
[69] First, the appellants say that the trial judge mischaracterized the evidence of their non-disclosure when concluding that it breached the respondent’s reasonable expectations. They argue that the trial judge failed to have regard to his own findings that:
- The respondent received financial statements from East West every year;
- The respondent and Hobza corresponded regularly and met annually;
- Discussions took place between East West’s and the respondent’s professional advisors;
- East West’s accountant wrote to the respondent’s advisor in 2000, satisfying the respondent’s inquiries regarding 1999 and 2000; and
- It was not the case that management compensation was not broken out in the financial statements with a view to concealing information from the respondent.
[70] The appellants say that in light of these findings, the trial judge committed a palpable and overriding error in finding that the respondent’s reasonable expectations were breached.
[71] I am not persuaded that the trial judge erred. In my view, the findings the appellants point to are not inconsistent with the trial judge’s conclusion that, in all of the circumstances, the respondent had a reasonable expectation that the financial information he was provided with would disclose the compensation paid to the Managing Directors. The respondent was the only shareholder who was not also a director and officer; he had been told that whenever East West made a profit, it would remain in the company or he would receive 10% of it; over the 22-year period no distributions had been paid to shareholders; the financial statements the respondent was provided with in the early years disclosed the Managing Directors’ compensation as a line item; the respondent had made inquiries about the level of compensation paid to the Managing Directors; and some of the financial statements he was provided with were misleading because they only disclosed part of the Managing Directors’ compensation. I reject this first argument.
[72] Second, the appellants say that BCE Inc. v. 1976 Debentureholders, 2008 SCC 69, [2008] 3 S.C.R. 560, makes clear that the conduct required to ground a finding of oppression, unfair prejudice or unfair disregard are different, and the trial judge did not specify which of these he found. Moreover, they argue, the conduct at issue did not rise to any of those levels. At the highest, it only amounted to the appellants sometimes refusing to respond to the respondent’s requests for information during the last few years. And even if the appellant’s conduct were seen as unfairly disregarding the respondent’s interests, it did not result in compensable harm.
[73] It can safely be said that the trial judge found the appellants’ conduct to be oppressive. In his costs endorsement following trial, the trial judge described his decision as finding that the appellants’ “conduct in awarding themselves excess compensation during the period 1993 to 2007, coupled with their conduct towards [the respondent] was oppressive and unfairly prejudicial”. He characterized that conduct as “egregious”, “outrageous” and “reprehensible”, justifying an award of substantial indemnity costs.
[74] The conduct on which the trial judge focussed began in 2005:
[13] Beginning with Hobza’s angry response in early 2005 to [the respondent’s] December 23, 2004 email that stated that the [appellants’] compensation “is not your business!”, the [appellants] and particularly Hobza, along with East West’s lawyer [Robin] McDonald, deliberately took steps to prevent [the respondent] from receiving information about their salaries.
[14] When [the respondent] raised the issue, rather than deal with it, they refused to address it. They forced [the respondent] to retain legal counsel and ultimately start an action to recover from them monies that they improperly received.
[75] I reject the appellants’ argument that because the trial judge did not invoke the descriptors “egregious, outrageous and reprehensible” in his trial reasons, his costs endorsement is inconsistent with his findings at trial, and his award of substantial indemnity costs accordingly cannot stand. Where on the range of conduct covered by the oppression remedy the non-disclosure fell became relevant only when faced with the task of fixing costs. Properly viewed, the costs endorsement supplements the trial reasons.
[76] Moreover, it is clear from his costs decision that the trial judge considered the non-disclosure together with the payment of the excess compensation as together warranting substantial indemnity costs. It does not matter that the non-disclosure in and of itself did not result in compensable harm.
[77] Therefore, the final question, before turning to the costs awarded by the trial judge, is whether the trial judge erred in principle or made a palpable and overriding error of fact in concluding that the non-disclosure conduct at issue, combined with the payment of excess compensation in circumstances where the Managing Directors had no regard to whether the compensation paid was fair and reasonable, amounted to oppression. I am not persuaded that the trial judge erred.
[78] At para. 104 of his reasons, the trial judge refers to BCE and properly instructed himself as to the varying scale of wrongful conduct reflected in the terms “oppression”, “unfairly prejudicial” and “unfairly disregards” – with oppression, a “wrong of the most serious sort” at one end, and “unfair disregard” at the other.[^4]
[79] And as this court has held, whether a shareholder has a reasonable expectation, and whether the actions of a corporation are oppressive, unfairly prejudicial to or unfairly disregard the interests of a shareholder are essentially questions of fact: Casurina Ltd. Partnership v. Rio Algom Ltd. (2004), 2004 CanLII 30309 (ON CA), 40 B.L.R. (3d) 112 (Ont. C.A.), at para. 24. The trial judge makes a fully-supported finding of deliberate high-handed conduct: the refusal to provide information to the respondent about compensation paid to the Managing Directors when asked.
[80] Nor am I persuaded that there is a basis to interfere with the trial judge’s award of costs on a substantial indemnity scale. This court will interfere with an award of substantial indemnity costs only if it is satisfied that the trial judge erred in principle or that the costs award is plainly wrong: Ford Motor Co. of Canada v. Ontario (Municipal Employees Retirement Board)(2006), 17 B.L.R. (4th) 169 (Ont. C.A.), at para. 12.
[81] The trial judge properly instructed himself that a finding of oppression does not always attract substantial indemnity costs, and, having characterized the appellants’ conduct as outrageous, egregious and reprehensible, determined that their conduct was sufficient to justify an award of substantial indemnity costs.
[82] The appellants argue that the trial judge failed to consider a number of significant factors that weighed heavily against a substantial costs award:
- They made good faith efforts to settle the action, a factor taken into account in Harmer v. McNeely Engineering Consultants Ltd., [1997] O.J. No. 4886 (Gen. Div.) at para. 10;
- The money that they improperly paid to themselves was overwhelmingly theirs, whether paid by dividend or executive compensation;
- The respondent profited significantly overall from his investment in East West; and
- As they say the trial judge found, their conduct was informed by advice from East West’s professional advisors.
[83] I take no issue with the first three factors the appellants advance. However, I will comment on the final factor. As expressed, it suggests stronger reliance on professional advisors than the trial judge found. The trial judge did not find that East West’s professional advisors told the Managing Directors that they need not provide copies of the Statement of Warehouse, Selling and Administrative Expenses to the respondent, or respond to the respondent’s requests for information about compensation. And while East West’s accountants may have explained that its active business income could be reduced to a level that would be taxable at the small business rate by paying management bonuses, the trial judge did not find that East West’s professional advisors told the Managing Directors that, in the circumstances, this was a proper means for determining their compensation.
[84] In any event, a trial judge cannot be expected to address every argument in his or her costs endorsement. The trial judge’s costs decision is 13 pages in length, and he set out the reasons why he determined that substantial indemnity costs were appropriate in this case. I am not satisfied that the trial judge’s decision to award substantial indemnity costs is plainly wrong.
[85] Although I would not interfere with the trial judge’s award of costs on a substantial indemnity scale, I would order that the questions of the quantum of costs and the cost consequences of Rule 49.10 be remitted to the trial judge for reconsideration.
[86] In fixing costs, the trial judge specifically considered the amount recovered by the respondent. The reasonableness of the quantum must be reconsidered in light of the reduced recovery. While this court may reassess the quantum of substantial indemnity costs awarded when it reduces the amount of damages (see 340812 Ontario Ltd. v. Canadian National Railway Co. (1997), 1997 CanLII 2783 (ON CA), 149 D.L.R. (4th) 575; Pirani v. Esmail, 2014 ONCA 145, 94 E.T.R. (3d) 1), as I explain below, in this case the reduction may have cost consequences under Rule 49.10 At a minimum, it highlights the reasonableness of the appellants’ settlement offer (Pirani at para. 77). For these reasons, I would return these questions to the trial judge.
[87] As noted in the introduction to these reasons, the appellants made an offer to settle the action for $300,000 inclusive of interest, plus partial indemnity costs. The trial judge’s award of damages ($250,000) and prejudgment interest ($49,793.83) was in total very slightly less than $300,000. He rejected the appellant’s argument that the judgment was therefore not as favourable as or less favourable than the offer to settle, explaining at para. 22 of his Costs Endorsement that “in comparing the terms of a judgment, all of the terms of the offer must be considered, including the provisions for costs: Rooney (Litigation Guardian of) v. Graham (2001), 2001 CanLII 24064 (ON CA), 53 O.R. (3d) 685 (C.A.).”
[88] The trial judge concluded, at para. 23 of his Costs Endorsement:
…[the respondent] is entitled to substantial indemnity costs of the action. The [appellants’] conduct which gives rise to the higher cost award occurred prior to the commencement of the action and therefore the higher cost scale should have been included as part of the Offer. Given the Offer was made on the eve of trial, the difference between partial indemnity and substantial indemnity costs was significant from a monetary perspective. In my view, therefore, the judgement was more favourable than the Offer and accordingly, the [appellants] cannot rely on the cost consequences of Rule 49.
[89] A judgment that provides for substantial indemnity costs will not always be as favourable or more favourable than a settlement offer that provides for partial indemnity costs. As the trial judge notes, when the settlement offer was made is relevant. However, the difference between the principal amount in the offer and principal amount of the judgment is also relevant. One only need imagine an offer to settle for $100,000, plus prejudgment interest and partial indemnity costs, and a judgment for $10,000, and substantial indemnity costs. Here, as noted above, the amount of damages awarded by the trial judge, and prejudgment interest thereon, nearly equalled the amount of the settlement offer. The $300,000 settlement offer exceeds the damages that I would award ($187,453.51) and prejudgment interest thereon ($37,336.12) by approximately $75,000. This is an important factor.
VI. DISPOSITION AND COSTS
[90] I would accordingly allow the appeal, in part, and reduce damages to $187,453.51, and prejudgment interest thereon to $37,336.12 (3.3% per annum, for 2,203 days). I would not disturb the award of costs on a substantial indemnity scale, but would return the questions of the quantum of those costs, and the cost consequences of Rule 49.10 to the trial judge for reconsideration, in light of the reduced damages award.
RELEASED:
“OCT -9 2014” “Alexandra Hoy A.C.J.O.”
“AH” “I agree E.E. Gillese J.A.”
“I agree P. Lauwers J.A.”
Schedule “A”
| Fiscal Year | Compensation Paid | Fair Market Compensation | Excess (Deficit) Before Tax | Tax Rate | Excess (Deficit) After Tax |
|---|---|---|---|---|---|
| 1986 | $40,000.00 | $300,000.00 | -$260,000.00 | 44.69% | -$143,806.00 |
| 1987 | $200,000.00 | $325,000.00 | -$125,000.00 | 42.98% | -$71,275.00 |
| 1988 | $385,600.00 | $350,000.00 | $35,600.00 | 40.55% | $21,164.20 |
| 1989 | $192,000.00 | $360,000.00 | -$168,000.00 | 39.08% | -$102,345.60 |
| 1990 | $302,000.00 | $365,000.00 | -$63,000.00 | 38.82% | -$38,543.40 |
| 1991 | $240,000.00 | $375,000.00 | -$135,000.00 | 38.25% | -$83,362.50 |
| 1992 | $270,000.00 | $425,000.00 | -$155,000.00 | 38.11% | -$95,929.50 |
| 1993 | $312,000.00 | $425,000.00 | -$113,000.00 | 36.55% | -$71,698.50 |
| 1994 | $599,600.00 | $450,000.00 | $149,600.00 | 35.58% | $96,372.32 |
| 1995 | $672,000.00 | $500,000.00 | $172,000.00 | 35.82% | $110,389.60 |
| 1996 | $502,000.00 | $625,000.00 | -$123,000.00 | 35.89% | -$78,855.30 |
| 1997 | $556,000.00 | $650,000.00 | -$94,000.00 | 35.89% | -$60,263.40 |
| 1998 (3 months) | $129,000.00 | $110,000.00 | $19,000.00 | 35.89% | $12,180.90 |
| 1999 | $980,500.00 | $500,000.00 | $480,500.00 | 35.86% | $308,192.70 |
| 2000 | $875,000.00 | $550,000.00 | $325,000.00 | 35.52% | $209,560.00 |
| 2001 | $743,700.00 | $625,000.00 | $118,700.00 | 35.12% | $77,012.56 |
| 2002 | $525,000.00 | $625,000.00 | -$100,000.00 | 34.12% | -$65,880.00 |
| 2003 | $630,000.00 | $650,000.00 | -$20,000.00 | 34.00% | -$13,200.00 |
| 2004 | $1,200,000.00 | $675,000.00 | $525,000.00 | 33.36% | $349,860.00 |
| 2005 | $1,500,000.00 | $700,000.00 | $800,000.00 | 35.36% | $517,120.00 |
| 2006 | $1,650,000.00 | $700,000.00 | $950,000.00 | 35.11% | $616,455.00 |
| 2007 | $807,150.00 | $750,000.00 | $57,150.00 | 35.11% | $37,084.64 |
| Total | $13,311,550.00 | $11,035,000.00 | $2,276,550.00 | $1,530,232.72 | |
| Respondent’s Share (12.25%) | $278,877.38 | $187,453.51 |
[^1]: Rules of Civil Procedure, R.R.O. 1990, Reg. 194. [^2]: The trial judge expressed doubt that this was the case in the period beginning in the mid-1990s. [^3]: Section 5 of the Third Schedule of the Act provides the following: (1) A complainant may apply to the court for an order under this Section. (2) If, upon an application under subsection (1) of this Section, the court is satisfied that in respect of a company or any of its affiliates (a) any act or omission of the company or any of its affiliates effects a result; (b) the business or affairs of the company or any of its affiliates are or have been carried on or conducted in a manner; or (c) the powers of the directors of the company or any of its affiliates are or have been exercised in a manner, that it is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer, the court may make an order to rectify the matters complained of. [^4]: BCE explains, at para. 92, that oppression connotes harsh and abusive conduct and is reserved for wrongs “of the most serious sort”. On the other hand: [93] “Unfair prejudice” is generally seen as involving conduct less offensive than “oppression”. Examples include squeezing out a minority shareholder, failing to disclose related party transactions, changing corporate structure to drastically alter debt ratios, adopting a “poison pill” to prevent a takeover bid, paying dividends without a formal declaration, preferring some shareholders with management fees and paying directors’ fees higher than the industry norm. [94] “Unfair disregard” is viewed as the least serious of the three injuries, or wrongs…. Examples include favouring a director by failing to properly prosecute claims, improperly reducing a shareholder’s dividend, or failing to deliver property belonging to the claimant. [Citations omitted.]