CITATION: Aquam Corporation v. Coffey, 2019 ONSC 7218
DIVISIONAL COURT FILE NO.: DC-27/19
DATE: 20191212
ONTARIO SUPERIOR COURT OF JUSTICE DIVISIONAL COURT
SACHS, MYERS. and O’BONSAWIN JJ.
BETWEEN:
AQUAM CORPORATION
Appellant
– and –
RICHARD COFFEY, LISA FIELDING and RICHARD CHRISTOPHER
Respondents
Dena Varah and Brian Kolenda, for the Appellant
Kevin O’Brien, and Robert Carson, for Richard Coffey and Lisa Fielding
Richard Christopher, in person
HEARD at Toronto: November 26, 2019
REASONS FOR DECISION
F.L. Myers J.
[1] Aquam Corporation appeals from the judgment of Gans J. dated November 2, 2018 fixing the fair value of the shares of the corporation at 30.4¢ per share and ordering Aquam to pay the respondent dissenting shareholders the corresponding value of their shareholdings under s.185 of the Business Corporations Act, RSO 1990, c B.16.
[2] Aquam submits that in arriving at the fair value of its shares, the application judge made several errors of law which led him to over-value the corporation’s shares. For the reasons that follow, I would dismiss the appeal.
Jurisdiction
[3] An appeal lies to this court under s.255 of the OBCA.
Standard of Review
[4] The standard of review in an appeal from the order of a judge is correctness for an error of law. The standard of review requires that we defer to the findings of fact made by the trial judge absent a showing of palpable and overriding error. For questions of mixed fact and law, the standard of review is correctness if there is an extricable question of law at issue. Otherwise, the palpable and overriding error standard applies. See: Housen v. Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235.
[5] Where a judge exercises her or his judgment to resolve a question for which the law provides a discretion, the standard of review is also deferential. In Elsom v. Elsom, 1989 100 (SCC), [1989] 1 S.C.R. 1367, the Supreme Court of Canada described the standard of review of an exercise of judicial discretion in this way:
The principles enunciated in the Harper case, supra, indicate that an appellate court will be justified in intervening in a trial judge's exercise of his discretion only if the trial judge misdirects himself or if his decision is so clearly wrong as to amount to an injustice.
[6] Appellate intervention in a discretionary decision is also appropriate where the lower court gives no or insufficient weight to relevant considerations: Friends of the Oldman River Society v. Canada (Minister of Transport), 1992 110 (SCC), [1992] 1 S.C.R. 3, at pp. 76-77.
[7] In all, an appellate court must defer to a judge’s exercise of discretion unless she or he makes an error in law - adopting the wrong legal principle or giving insufficient weight to a relevant factor - or if the decision is clearly wrong. Otherwise the appeal court cannot substitute its own judgment call in place of the judgment of the judge whose decision is under review.
Valuation Proceedings
[8] Although corporate affairs are generally controlled by the votes of a majority of the shareholders, under s.185 of the OBCA, the majority cannot force minority shareholders to accept certain, listed fundamental changes to the corporation. The statute provides that shareholders may dissent from a fundamental change imposed by the will of the majority. Dissenting shareholders are given the right to sell their shares back to the corporation and to be paid the “fair value” of their shares. To that end, the corporation is required to make a bona fide offer of fair value to the dissenting shareholders. In this case, Aquam offered to pay the respondents amounts equivalent to 3¢ per share.
[9] The respondents declined the corporation’s offer and exercised their right to ask the court to determine the fair value of their shares.
[10] The task of fixing a fair value for a corporation’s shares is a unique form of proceeding. The issues are infused with judgment calls based on the evidence and usually guided by expert opinion evidence. As will be discussed below, the experts make their own judgment calls for the judge to assess and consider in forming her or his own judgment. The task is fact-laden and requires the judge to draw inferences of fact or mixed fact and law to arrive at a valuation that in her or his judgment most closely approximates the value of the corporation on the given valuation date.
[11] In Smeenk v. Dexleigh Corp., 1990 6935 (ON SC), at para. 36, Henry J. adopted the following apt description of valuation proceedings:
Further in Cyprus Anvil Mining Corp. v. Dickson (1986), 1986 811 (BC CA), 8 B.C.L.R. (2d) 145, 33 D.L.R. (4th) 641 (C.A.), Lambert J.A. referred to a number of U.S. authorities and observed at p. 158 B.C.L.R.:
It is not necessary for me to analyze those cases or to quote from them. The point that they emphasize is that the problem of finding fair value of stock is a special problem in every particular instance. It defies being reduced to a set of rules for selecting a method of valuation, or to a formula or equation which will produce an answer with the illusion of mathematical certainty. Each case must be examined on its own facts, and each presents its own difficulties. Factors which may be critically important in one case may be meaningless in another. Calculations which may be accurate guides for one stock may be entirely flawed when applied to another stock.
The one true rule is to consider all the evidence that might be helpful, and to consider the particular factors in the particular case, and to exercise the best judgment that can be brought to bear on all the evidence and all the factors. I emphasize: it is a question of judgment. No apology need be offered for that. Parliament has decreed that fair value be determined by the courts and not by a formula that can be stated in the legislation. [Emphasis added.]
[12] In upholding Henry J. the Court of Appeal added at 1993 8594 (ON CA):
The issue of who has the onus of proof in cases such as this was raised by the appellants. It is merely another aspect of the issues of availability of information and appointment of an appraiser. There is no doubt that the statute places the onus on the court to place a "fair value" on the shares. It has been held, and in our view correctly, that there is no ultimate onus on either party to prove or disprove that any particular value is the "fair value" for the shares. Rather, each party bears the onus of adducing evidence to substantiate its position. The court may, as in other types of cases, accept all or part of the evidence -- expert or otherwise -- tendered by any party, but must finally decide, on an assessment of all the evidence, what it considers to be a "fair value". The ultimate onus is on the court, rather than on either of the parties: see Cyprus Anvil Mining Corp. v. Dickson (1982), 1982 741 (BC SC), 40 B.C.L.R. 180, 20 B.L.R. 21 (S.C.); Robertson v. Canadian Canners Ltd. (1978), 4 B.L.R. 290 (Ont. H.C.J.); Manning v. Harris Steel Group Inc. (1986), 1986 754 (BC SC), 7 B.C.L.R. (2d) 69, [1987] 1 W.W.R. 86 (S.C.). [Emphasis added.]
[13] I bear in mind that in fixing a value of the corporation in this case, the experienced application judge was exercising his judgment to essentially find a hypothetical value based on often hypothetical facts and scenarios. While the task remains one to be performed judicially and is subject to review on the regular standards of review, making these kinds of judgment calls is often as much art as science.
The Basic Facts
[14] I will deal with facts relevant to each of the grounds of appeal discussed below. All that needs to be understood at this stage is that Aquam is a company with operations here, in the UK, and the US. As found by Gans J. “[i]t manufactures and installs various technologies designed to rehabilitate deteriorating, failing or contaminated pipes, principally for water and natural gas pipe installations”.
[15] On April 18, 2017, Aquam completed a refinancing transaction with New World/Credit Suisse (“NWCS”). Implementation of the transaction required the corporation to amend its articles of incorporation to create new classes of convertible preferred shares to be issued to the investor as consideration for its fresh funding. The respondents exercised their statutory right to dissent from the transaction. They say that the transaction was unnecessarily dilutive and prejudicial to the corporation’s common shareholders. Management and the board of directors, by contrast, believed that the company was facing a financial crisis and required this transaction to stay in business and to prosper in future.
[16] Under the statutory valuation scheme, the judge was required to fix the fair value of the respondents’ common shares on the day before the transaction closed i.e. April 17, 2017. The statute sets the valuation date as the day before the transaction closed to ensure that the dissenting shareholders do not “reap the benefits” of the transaction from which they dissented. See: Brant Investments Ltd. v Keeprite Inc., 1991 2705 at para. 104. This is sometimes referred to as the “synergy rule”. Under that rule, the valuation is conducted “without regard to information and events that supervened after the day of the resolution”. See: Smeenk, at para. 40.
[17] It is common ground that at the valuation date Aquam needed funding to survive. The judge aptly found it to be in a straitened condition. Both sides’ valuation evidence therefore involved assumptions about when or how the corporation might have been able to obtain alternative financing.
The Grounds of Appeal
[18] Aquam raised three principal grounds of appeal. It argues that:
a. the application judge erred in law by failing to value the corporation on a liquidation basis. In particular, the judge erred in law by valuing the corporation on a going concern basis in spite of the allegedly uncontroverted evidence that showed that without the NWCS transaction, the corporation would likely have failed;
b. the application judge erred in law by deciding on no evidence that the corporation’s cash flow forecast as at the valuation date should be adjusted on the hypothetical notion that it would have taken the corporation only three months to close an alternative refinancing transaction so as to enable it to achieve the projected earnings in the cash flow forecast. Aquam argues that the judge ought to have accepted the judgment call of its expert that the corporation needed at least 8.5 months to close a hypothetical, alternative refinancing transaction. Had he done so, he would then have adjusted the valuation downward further than he did; and
c. The application judge erred in law by failing to rule upon and fix the value of the respondents’ shares with reference to the likelihood that in any hypothetical, alternative refinancing of the corporation, some creditors would have exercised conversion rights attached to their outstanding debt so as to dilute the existing shareholders and decrease the value of the corporation’s shares proportionately.
[19] I will address each ground individually.
Liquidation Value or Going Concern Value
[20] Aquam submits that the uncontested evidence of its senior executive Michael Vivaldi was that:
a. As at April 17, 2017, if the NWCS transaction had not closed, senior management, including him, would likely have left the corporation;
b. Upon management bolting, the financial advisor would likely have terminated its retainer;
c. Senior secured creditors would likely have enforced their security rights as all of their debt had come due on April 15, 2017 and they would not likely have agreed to forbear further; and
d. The company was hopelessly insolvent and illiquid.
[21] Based on the corporation’s evidence and his own analysis, Aquam’s highly experienced expert, Robert Low, assessed that “there was an equal likelihood of Aquam being a going concern at the Valuation Date as not.” He therefore performed valuations both on a liquidation basis and on a going concern basis that he presented as a “low” and “high” scenario respectively. Unsurprisingly, the valuation based on a liquidation scenario would have left no value for common shareholders. By contrast, Mr. Low’s going concern valuation produced a value of approximately 10¢ per share.
[22] The respondents submit that there was evidence before the judge concerning a number of proposed alternative transactions that the company had put to one side to allow management to concentrate on completing the chosen NWCS transaction. There was evidence about an indicative offer received from a suitor in January, 2017. That party had completed preliminary due diligence but indicated that it would need significant further time to finalize its due diligence exercise and close. There was email back-and-forth between the suitor and Aquam management and there was some ongoing interest in the alternative bid expressed at the corporation’s board of directors.
[23] The suitor’s indicative offer would have produced an implied per share value of approximately 58¢. This would likely have fallen to 42¢ per share once the suitor learned that Aquam’s Q4 2016 results were well below projections. The price, and therefore its implicit value, might well have fallen further in negotiations (had they occurred) because Aquam’s Q1 2017 results were even worse than its prior year’s results. But the parties never got that far as the board of directors and management chose to shelve the bid rather than to play it off against NWCS.
[24] There was also evidence that a UK broker had a number of potential bidders who had expressed more than passing interest in financing transactions with Aquam.
[25] The experts for both sides felt it reasonable to value the business on a going concern basis. They both also accepted the cash flow projection approved by the board of directors in relation to the NWCS deal as applicable to an alternative, hypothetical transaction if the NWCS deal did not close.
[26] Moreover, both experts took account of the financial weakness of the corporation in assessing an appropriate discount rate to be applied to capitalize the future cash flows for their going concern valuation analysis. Both experts recognized there was substantial risk associated with Aquam’s ability to produce its cash flows as projected. Both applied discount rates of over 20% to reflect risks that expressly included liquidity and insolvency risks. Mr. Low’s proposed discount rate was a few percentage points higher than the rate opined by Mr. Rudson. Both agreed that the company-specific risk assessment that each of them made as part of the discount rate build-up was simply a judgment call.
[27] Gans J. dealt with this issue as follows:
[27] I am not prepared to accept the Applicant’s position that the liquidation approach must obtain in the circumstances of this case. While no doubt the Company on Valuation Date was in straightened [sic] financial circumstances, was debt-laden and had to endure high and increasing interest and royalty expenses, and was having difficulty in retaining senior management, the best opinion Mr. Low could provide on this issue was that there was an “equal likelihood of Aquam being a going concern on Valuation Date as not.” Respectfully, that assertion, which dots his report in several instances, does not establish this proposition on a balance of probabilities, which is fundamental to the success of this argument.
[28] That said, I am not persuaded on the evidence that the Company should not be valued on a going-concern basis, although that conclusion is tempered in some respects later in these reasons for judgment.
[29] As indicated, Aquam was in straightened [sic] circumstances, no doubt occasioned by its seemingly aggressive corporate acquisition program. Indeed, by its own acknowledgement in its then recently published Annual Consolidated Statements, the Company made clear that it was compelled to obtain financing through debt or equity to continue its operations. I would observe parenthetically that appropriate financing could only have been achieved through some form of equity deal since its debt obligations as of the Valuation Date were extensive if not oppressive.
[30] As a consequence, in the year preceding April 2017, it had undertaken a concerted and planned program to refinance the Company, which, from all indications, generated more than passing interest from private equity firms and financial institutions.
[31] While no doubt the solvency ratios upon which Mr. Low relied painted a “difficult” picture, the other financial indicia described by Mr. Rudson and the underlying proprietary technology which underpinned some of the activity of the Company supports my conclusion that there was sufficient interest in Aquam as a viable but debt-laden enterprise, sufficient to attract the interest of more than mere tire-kickers. I would also observe that its accountants had not at the time of the preparation of its last annual consolidated statement issued any cautionary note that its continuation as a going concern was not possible, but for the note set out above. [Emphasis added. Footnotes omitted.]
[28] In the sentence that I have emphasized above, Gans J. referred expressly to the evidence concerning management retention and the other points raised in Mr. Vivaldi’s evidence. In his judgment however, he felt that the company’s proprietary technology and alternative suitors provided a sufficient basis to apply a going concern approach. This was Mr. Rudson’s view as well. Ms. Varah objects to Gans J. referring to Mr. Low’s evidence being insufficient to tip the balance of probabilities. There was no burden of proof on Mr. Low as an expert witness. While that is true, there was a burden on Aquam if it wished to establish the proposition that the company was not a going concern. In my view, the judge simply noted that Mr. Low’s equivocal evidence was not enough to do so.
[29] Gans J. made a further holding on this issue that the Appellant submits constitutes an error of law:
[32] Furthermore, while there is some debate that this notion might offend the Synergy Rule, I am of the view, as a fall-back position, that I am entitled to consider the mere fact that an agreement had been entered into in respect of the Transaction, although not closed, as some
evidence as to the ongoing nature of the Company, at least in the estimation of a consortium that was prepared to invest in Aquam. I hasten to add, however, that this observation, as was noted by Mr. Rudson, is not to be construed as dispositive of the issue of “going-concern”.
[30] Gans J. used the fact of the existence of the NWCS deal as a circumstantial guarantee of the reliability of his holding that the company could be refinanced as a going concern. NWCS was not insisting on buying the company out of receivership or CCAA proceedings as buyers can do to protect themselves from aggressive creditors. He simply made note of the fact that NWCS was refinancing the business as a going concern. Ms. Varah submits that this violates the synergy rule by allowing the dissenting shareholders to refer to the deal from which they dissented. I disagree. Gans J. did not allow the dissenting shareholders to take any benefit or uptick in value as a result of the transaction in which they declined to participate. He did not refer to any “information and events that supervened after the day of the resolution”. Rather, he used the existence of a going concern transaction for the company on the valuation date as a “fall-back position”, although he made it clear that it was not dispositive of the issue. It provided him with some comfort in ruling that the company should be treated as a going concern at the valuation date to see that an arm’s length party was doing just that.
[31] Nor do I see how this might run afoul of the synergy rule as articulated by Henry J. in Smeenk. In that case, Henry J. found on uncontested evidence that the corporation being valued was incapable of continuing without the amalgamation under consideration. As discussed above, Gans J. made the opposite holding in this case. While the synergy rule is applicable here, the fact-specific concerns expressed by Henry J. about the inappropriate positioning by the dissidents before him are not.
[32] In all, the judgment call made by Gans J. to value Aquam on a going concern basis is entitled to deference. I see no error in principle in how he dealt with this issue, nor was the result clearly wrong.
Postponing the Cash Flow Projections
[33] The cash flow projections relied upon by both experts as the basis for their going concern valuations was prepared by management and approved by the board of directors in connection with the NWCS transaction. That is, they were premised on the corporation being debt free and properly capitalized to carry on business after a refinancing transaction had occurred.
[34] It was Mr. Low’s judgment that if the NWCS deal did not close and an alternative deal had to be found, it would take time to obtain the financing to enable the corporation to achieve the results in the cash flow forecast. Any other buyer would need time to negotiate, conduct due diligence inquiries, and close. Mr. Low opined that a period of 8.5 months was reasonable and he discounted the cash flow projections to reflect this deferral.
[35] Mr. Rudson did not accept that any further discount due to deferral was appropriate as a matter of valuation theory. In his view, a going concern valuation of a company’s results as at a valuation date necessarily assumes that another transaction is implemented. The existence of various risks that this may not occur is already considered in the valuation process. In a discounted cash flow analysis - that both experts said was appropriate and used - the valuator exercises judgment to determine the appropriate discount rate to apply to capitalize forecast cash flows. The judgment involved in determining the appropriate discount rate includes an assessment of the risks of illiquidity and insolvency. See, for example, pp. 36 and 37 of Mr. Rudson’s report dated April 13, 2018.
[36] Moreover, it was Mr. Rudson’s view that the corporation’s ability to obtain its projected results did not turn on the precise mechanism used by the owner to finance the assets. He said in cross-examination:
The projections are based on the operating assets. There’s nothing in them that suggests that they’re - - depend on certain level of debt or no debt or an extreme amount of debt. They are based on the company’s ability to generate cash flows in the future based on its operating assets as at the valuation date. (See: transcript of the cross-examination of Wayne Rudson taken May 18, 2018, p. 109, at line 16.)
[37] Furthermore, Mr. Rudson testified that even if the assets were bought out of receivership (i.e. if Aquam failed due to illiquidity) another owner could obtain the projected results on the assets. He therefore did not build any delay into his use of the company’s cash flow projections.
[38] Mr. Low’s evidence at the hearing indicated that the question was one of judgment. For example, when asked whether Aquam could have gone back to the suitor whom it sidelined and asked them to accelerate the process, he agreed it could have, but that it was his view that it would take 8.5 months to get them up to speed. The following exchange then occurred:
THE COURT: Well, actually, three concepts. Why here in Rudson, that it shouldn’t be anything; two, 8.5 versus 4 versus 3, you know [the suitor] said they only need four months. There are a lot of guys who’d have access to the documents for them.
A: But nobody had had access since January. And so, there’s a fair amount of time and some negative results that have happened that’s going to impact them. They’re going to have to look at it all, they’re going to have to do it. So, could I have selected four months? I probably could have…I thought it would take longer. [Emphasis added.]
[39] Gans J. considered the parties’ respective positions and the experts’ respective evidence. He rejected Mr. Rudson’s view that one had to approach the valuation with the assumption that an alternative purchaser would finance its engagement as it pleased and that this was irrelevant to the corporation’s ability to achieve the projected cash flows. He ultimately held:
[47] I hasten to observe that I am not to be taken to suggest that any part of the free cash flows would theoretically be devoted to discharge the existing debt or service that debt. I am simply not persuaded that the operation of the Company was sufficient to generate the revenue projections internally.
[48] Conversely, I am not persuaded that Mr. Low’s assessment of the time delay is appropriate. In my opinion, it would not, on a theoretical basis, have taken the Company 8.5 months to put equity financing in place, had Aquam been forced to canvass the waterfront, yet again, for alternatives to the Transaction after the Valuation Date. In the first place, that process was relatively mature as of mid-April 2017, including but not limited to the then existing activities of management and its consultant Raymond James Ltd. While speculative in some respects, I was not persuaded that the “interest” previously exhibited by [the suitor] and [the UK broker] could not be resurrected on a more timely basis.
[49] Accordingly, I am of the view that a time delay of 3 months is appropriate in the circumstances.
[40] Ms. Varah argues that the application judge picked three months out of the air with no evidentiary support. I disagree. Mr. Low confirmed that the prediction of the corporation’s availability to complete a hypothetical, alternative transaction was a subjective judgment call. For myself, I am not entirely comfortable with adding what amounts to yet another subjective educated guess into the valuation process that is already studded with judgment calls, including at least one that is already based on the risks posed by the corporation’s illiquidity and insolvency as discussed above. Absent evidence that a deferral is an appropriate valuation methodology, in my view, an adjustment to the discount rate would have been a more consistent and simpler way to approach this question.
[41] However, is was not my call to make. The application judge disagreed with Mr. Rudson’s approach and the dissenting shareholders have not cross-appealed on that point. The appellant does not object to the judge finding that a deferral of the cash flow forecast was appropriate. Rather, it says that he should have deferred it more.
[42] Ultimately this issue was another judgment call on the facts that was for the application judge to make. He recited the opposing positions and evidence, provided his reasons for rejecting both sides’ extremes, and arrived at a mid-point judgment. As discussed with Mr. Low, this was an available judgment call, although it is not one that he shared. I see no error in the judge’s finding of fact or with the exercise of his judgment on the evidence before him.
Dilution
[43] Mr. Low’s initial report indicated that in valuing any hypothetical, alternative transaction there was an issue of dilution. There were several creditors who held differing types of convertible debt instruments. In the event that any of the creditors could profit by converting their debt to equity at a price that was lower than the price implied by a hypothetical, alternative transaction, he would have assumed that the creditor would convert to take advantage of that opportunity for profit. For example, if a creditor had a hypothetical entitlement to convert its debt to shares at a price of, say, $1.00
per share, and if the proposed hypothetical, alternative transaction would have implied a price of $2.50 per share, then it is fair to assume that the creditor would convert to reap the guaranteed profit of $1.50 per share. The effect of the creditor converting its debt to shares would be that there would be more shares outstanding overall. That means that in calculating the value per share, there would be a bigger denominator and consequently a lower price per share after conversion than before. The new shares are said to “dilute” the value held by the pre-existing shareholders by making them distribute the value of the deal among a greater number of shares.
[44] Mr. Low identified one series of warrants that he said was, by its terms, always available to profit on any transaction that the corporation might consummate. But neither he nor Mr. Rudson actually accounted for the dilution in their initial valuation reports. Mr. Low raised the issue again in his supplemental report and that report provided a revised calculation on a fully-diluted basis. Gans J. asked the experts about the role of dilution and, unsurprisingly, their evidence differed. Mr. Rudson opined that it would be inappropriate to assume dilution in this valuation process.
[45] One creditor converted a portion of its debt to equity at an earlier stage of the process, ostensibly to ensure that the NWCS transaction would have the required 66.67% shareholder support required to amend the corporation’s articles. That conversion was reflected in the valuations conducted as at April 17, 2019.
[46] The judge did not mention dilution in his Reasons and did not utilize a value that reflected dilution as had been suggested by Mr. Low. It is well-understood that a judge’s reasons do not have to deal with every point raised in the evidence. Moreover, we note that the valuation was required to be and was conducted as at the day before the NWCS transaction closed. On April 17, 2017, apart from the one creditor mentioned above whose shares were counted, no other creditor had converted. No doubt they were expecting to be paid out by the NWCS transaction. Nevertheless, factually, no further dilution had occurred by the valuation date and there is no reason to assume that in any hypothetical, alternative refinancing of the corporation the situation would be different.
[47] Overall, while the issue of dilution was mentioned in the evidence, I see no indication that it was pressed in any significant way before Gans J. In my view, he made no error in applying the shareholdings as they stood at the valuation date in light of the evidence before him.
Outcome
[48] For these reasons the appeal is dismissed. As agreed by the parties, the respondents are entitled to their costs of the appeal, fixed in the amount of $35,000.00.
F.L. Myers J.
I agree _______________________________
Sachs J.
I agree _______________________________
O’Bonsawin J.
Release Date: December 12, 2019
CITATION: Aquam Corporation v. Coffey, 2019 ONSC 7218
DIVISIONAL COURT FILE NO.: DC-27/19
DATE: 20191212
ONTARIO SUPERIOR COURT OF JUSTICE DIVISIONAL COURT
SACHS, MYERS. and O’BONSAWIN JJ.
BETWEEN:
AQUAM CORPORATION
Appellant
– and –
RICHARD COFFEY, LISA FIELDING and RICHARD CHRISTOPHER
Respondents
REASONS FOR DECISION
F.L. Myers J
Released: December 12, 2019