COURT FILE NO.: 08-CV-43544
DATE: 2013/02/21
SUPERIOR COURT OF JUSTICE - ONTARIO
RE: Allen-Vanguard Corporation v. Richard L’Abbé et al
BEFORE: Master Macleod
COUNSEL: Eli S. Lederman for Allen Vanguard Corporation
Thomas. G. Conway for the “offeree shareholders”
REASONS
[1] This is a motion by Allen-Vanguard Corporation to amend its pleadings. Most of the amendments simply particularize the allegations or update the pleadings. The only controversial amendments are those proposed to paragraphs 1 (a) and 2 (f). The first of these is a proposed amendment to the prayer for relief to increase the claim from $40 million to $650 million. The second is the addition of the phrase “fraudulent misrepresentations and” to the paragraph which currently reads “breaches of representations and warranties” and claims indemnification for damages from the defendants.
[2] Ordinarily amendment to raise the quantum of damages is granted as a matter of course because of the mandatory language of Rule 26.01. In this case however the defendants allege that the amendments fundamentally change the nature of the litigation. They oppose this on the basis that read in context it is untenable at law, is highly prejudicial and is an abuse of process.
[3] I have given these submissions careful consideration but ultimately conclude that pursuant to Rule 26.01 leave must be granted.
Background
[4] The facts and allegations underlying this litigation have been set out in some detail in earlier reasons.[^1] For purposes of this motion it is simply necessary to repeat that Allen-Vanguard Corporation purchased all of the outstanding shares of Med Eng Systems Inc. in September, 2007 for roughly $650 million. Subsequently Med Eng was merged with another subsidiary of Allen Vanguard to become AVTI and ultimately was merged with Allen Vanguard itself so that currently Med Eng and Allen Vanguard are one and the same.
[5] Med Eng was in the business of supplying protective products for military, police and security services. One of its major customers was the U.S. military. Central to this litigation is the allegation that management of Med Eng failed to disclose material risks in relation to the continuation of the key U.S. military contract and also misrepresented the extent of contingent liabilities, tax liabilities, warranty claims and other contractual and litigation risks. The action was based on breach of warranty, misrepresentation, and fraud.
[6] The central document which governs the rights between the parties is the Share Purchase Agreement (SPA) dated August 3rd, 2007. This is an agreement between Allen Vanguard, Med Eng and the Offeree Shareholders. The Offeree Shareholders are the defendants to this action. They are Richard L’Abbé, 1062455 Ontario Inc., Growth Works Canadian Fund Ltd., and the Schroder entities collectively referred to as Schroder Canada and Schroder UK. These were the controlling shareholders of Med Eng. There were also minority shareholders who are not party to the SPA but whose shares were also acquired and who would have received their proportionate share of the purchase price. Other than Richard L’Abbé, none of the offeree shareholders are individuals and none of the members of Med Eng management were offeree shareholders.
[7] The structure of the SPA is very particular in its structure. Ordinarily in an agreement of purchase and sale one would expect the vendors to give or withhold representations and warranties and to be liable for breach of the agreement. In this case however, other than the warranties concerning ownership of the shares, it is Med Eng itself which gives the warranties and representations concerning its books, records, financial statements, assets, contracts, commitments, employees, taxes, regulatory compliance, and other material disclosure under the signature of its then CEO.[^2] Pursuant to the agreement part of the purchase price, $40 million, was deposited into an escrow fund and is available as a price adjustment fund to satisfy any claims for breach of warranty. Though this fund is the property of the offeree shareholders in the absence of proven claims, it is available to indemnify Allen Vanguard for any breach of the warranties and representations given by Med Eng.
[8] For purposes of this motion, the critical provision of the SPA is Article 7 dealing with indemnification. The clear intent of Article 7 is to limit any liability of the offeree shareholders and to limit any remedy by Allen Vanguard to a claim against the escrow fund. There are however exceptions for fraud. A critical question for purposes of the motion (and at trial if the amendment is granted) is whether or not a claim for more than $40 million may be maintained against the offeree shareholders if Med Eng management acted fraudulently?
[9] Subsequent to the closing of the transaction and assuming control of Med Eng , Allen Vanguard was disappointed to find that the new acquisition did not live up to its promise. Difficulties developed in the contract with the U.S. military and with certain other relationships. Allegedly as a result of “MES’s misrepresentations and breaches of representations, warranties and covenants” Allen Vanguard itself, in the words of the amended statement of claim, “spiralled into insolvency in the months following the transaction.”[^3] In 2009 Allen Vanguard sought protection from creditors and a plan of arrangement and reorganization under the CCAA.[^4]
[10] When this litigation was commenced, Allen Vanguard pleaded as follows:
(a) “indemnification and/or damages for fraudulent and/or negligent misrepresentation and breach of contract in the amount of $40,000,000 which shall be distributed to Allen-Vanguard Corporation in accordance with the terms of the Escrow Agreement as defined herein”.[^5]
(e) “as a result of the breaches of representation and warranties by MES, the Defendants are directly liable to indemnify Allen-Vanguard for the damages which have been caused to Allen-Vanguard”.[^6]
[11] At no time has it been asserted that any of the offeree shareholders committed fraud nor that the offeree shareholders made any representations or misrepresentations. With the exception of Paul Timmis, who is party to a related proceeding and who figures prominently in the statement of claim, none of the individuals who are said to be responsible for the misrepresentations are the subject of individual claims. For obvious reasons (since it would have made no sense to sue its own subsidiary when the action was commenced and since Allen Vanguard cannot maintain an action against itself now that it is amalgamated) Med Eng is not a defendant to Allen Vanguard’s claim. Nevertheless throughout the statement of claim the misrepresentations and breaches of duty are pleaded as acts of “MES”. That is Med Eng. Of course the former shareholders generally and the offeree shareholders in particular were the beneficiaries of the fraud, if fraud there was, so as vendors it is from them that Allen Vanguard seeks damages.
[12] The disputed amendments would change the claim to read as follows:
(a) “indemnification and/or damages for fraudulent and/ or negligent misrepresentation and breach of contract in the amount of $650,000 of which $40,000,000 shall be distributed to Allen-Vanguard in accordance with the terms of the Escrow Agreement as defined herein.”
(f) “as a result of the fraudulent misrepresentations and breaches of representations and warranties by MES, the Defendants are directly liable to indemnify Allen-Vanguard for the damages which have been caused to Allen-Vanguard.”
[13] The change to paragraph 2 (e) (now paragraph 2 (f) as a consequence of other amendments which are not opposed) is by itself of little moment. Firstly it is in a paragraph headed “overview” and secondly it is already pleaded that the “misrepresentations” were “fraudulent and\or negligent misrepresentations”. But there can be no doubt that the change to the prayer for relief from $40,000,000 to $650,000.00 read in combination with this change is a fundamental change to the litigation in substance if not in form. What is happening is that instead of simply laying claim to the entire escrow fund, Allen Vanguard is now seeking a full refund of the purchase price. The original claim was almost a claim in rem since, apart from the claim for pre-judgment interest and costs, it sought damages to be distributed to the plaintiff from the escrow fund. Now the damages in excess of the escrow fund will be sought at large against the “defendants” jointly and severally.
[14] At all previous stages in the litigation it has been conducted on the basis that the entitlement to the escrow fund was the ultimate question in issue. This is apparent not only from the pleading but from the previous endorsements and case conference orders. The allegation of fraudulent misrepresentation in that context appeared almost gratuitous because it has never been necessary to prove that the misrepresentations were fraudulent to lay claim to the fund. Conversely this change to the pleading will be totally dependent on proving fraud. The limiting words of Article 7 clearly apply except in case of fraud. The plaintiff does not seek rescission of the SPA nor of the sale itself.
[15] Because this amendment is thus potentially “game changing” and is made only 8 months before the scheduled trial date, the defendants view it as an improper tactic designed to strengthen the hand of the plaintiff in upcoming mediation. Their position is that it should be refused by the court on the basis that the claim is untenable at law, is highly prejudicial and is an abuse of process.
The test for amending pleadings and refusing an amendment
[16] I need not repeat at length the test for amending a pleading. “On motion at any stage of an action the court shall grant leave to amend a pleading on such terms as are just, unless prejudice would result that could not be compensated for by costs or an adjournment.”[^7] Of course the proposed pleading must be a proper pleading. It must therefore meet the requirements of Rule 25 and must be tenable at law. It may be refused if it creates unreasonable prejudice for the defendants or if it is a mere tactical amendment sought for an improper purpose.[^8]
[17] It follows that if the amendment is indeed untenable at law, highly prejudicial or an abuse of process it may be refused. A plea is untenable if it is impossible of success at trial otherwise it should not be refused at the pleadings stage.[^9] Though prejudice may be inferred in certain circumstances, the prejudice must be such that it cannot be remedied by a costs award or by other terms such as adjournments, setting peremptory dates for the party seeking the amendment, additional discovery rights or security for costs. Moreover the prejudice must be prejudice that flows from the fact of the amendment and not from the claim itself. Simply facing the prejudice that would be inevitable as the result of any successful plea is insufficient.[^10] As for abuse of process, it is for the party asserting abuse to demonstrate that there is an illicit purpose for the amendment constituting grounds for refusal. If I am not persuaded that one or more of these barriers exists then the amendment must be granted on appropriate terms.
Analysis
[18] The court is constrained to decide a motion such as this on the basis of the evidence actually before it and not on the basis of speculation and supposition or of positions put forth in argument that are not supported by the record. The only affidavit evidence before the court is an affidavit of an associate lawyer tendered on behalf of the moving party. That affidavit addresses the reasons for seeking the amendment but little else. The defendants have not tendered any affidavit. Accordingly the motion must be decided on the basis of the one affidavit, certain discovery and cross examination transcripts, the pleadings, the proposed amended pleading and the documents incorporated into the pleadings by reference. In particular I have before me the SPA and the Escrow Agreement. As this matter is case managed and I have heard all of the motions and case conferences I am also familiar with previous findings, the timetable for the proceeding and the litigation history which I would be entitled to take into consideration as well.
[19] Dealing firstly with the question of whether or not the increased claim is tenable at law, it may not be. This is because the rights of the parties are governed by the SPA and as described above the intent of that document is in part to protect the offeree shareholders from liability by limiting any claims to claims against the escrow fund. All of the critical representations and warranties were given in fact and in law by Med Eng management on behalf of the corporation being acquired and not by the vendors, the offeree shareholders.
[20] In article 7.06 which expressly survives termination or rescission of the contract, all parties agree that the sole remedies of any party against the others for any inaccuracy or misrepresentation are the remedies under Article 7 itself. The same article contains a provision that all parties waive any remedies against the other parties except for those set out in Article 7 “other than those arising with respect to any fraud”. Read in the most favourable light to the plaintiff this means that in the case of fraud the plaintiff is not limited to the remedies set out in Article 7. But of course that does not create a right of action against the offeree shareholders.
[21] Similarly Article 7.02 which provides that the corporation will indemnify the purchaser for any breaches of representation and warranty and that such claims are limited to the amount in the escrow fund contains the words “except in cases of fraud”. This clearly anticipates that if the plaintiff can show fraud, it will not be limited to the amount in the escrow fund. Once again however, notwithstanding that it would in most cases be impractical for a purchaser to assert a claim against the corporation it is purchasing, the liability is expressed to be liability of Med Eng and this paragraph does not create a specific right of action against the offeree shareholders. 7.02 (5) on the other hand specifically provides that the sole recourse of the purchaser against the corporation or the offeree shareholders shall be the “Indemnification Escrow fund” except in the case of deficiency of title to the shares or “in respect of liability of any Shareholder … under any claim attributable to fraud of that shareholder”.
[22] Since there is no fraud asserted against any defendant offeree shareholder, the defendants contend that this provision in article 7.02 (5) is a complete defence to a claim beyond the $40 million in the escrow fund. They may be right. Mr. Conway puts this argument persuasively and it is consistent with the intent of the agreement to limit the exposure of the vendors. Nevertheless I am not able to say with certainty that this is the only possible interpretation of the agreement. Mr. Lederman argues that no court can condone an interpretation which would unjustly enrich the former shareholders at the expense of the plaintiff if it was a victim of fraudulent misrepresentation. There is sufficient ambiguity in these interrelated provisions that I am unable to find only one possible interpretation of the contract. I cannot say that on the face of the agreement the plaintiff could never succeed.
[23] Accordingly the claim must be regarded as tenable. I could not strike it under Rule 25.11 nor, were I a judge, under Rule 21.01.
[24] The question of delay in seeking the amendment is more troubling. The affidavit evidence is to the effect that the decision to amend the claim was made after the discovery of Mr. Timmis. The plaintiff believes that evidence given by Mr. Timmis is an admission of material misrepresentation and non disclosure concerning amongst other things knowledge that the U.S. military was proposing “head to head tests” between the Med Eng product and the products of competitors. In other words the affidavit explains why Allen Vanguard now believes it has stronger evidence of fraudulent misrepresentation. There is however nothing in the affidavit that asserts that anything has occurred to suggest that the damages incurred by Allen Vanguard have changed or why Allen Vanguard earlier believed it was limited to claiming against the escrow fund and has now apparently changed its view. It appears the explanation is simply that encouraged by the discovery evidence and believing it has a better chance of success, the plaintiff has reconsidered its upside on damages and now wants to “go for broke”.
[25] There is authority from the Court of Appeal that “while delay is not in and of itself a basis for refusing an amendment, there must come a point where the delay is so long and the justification so inadequate that some prejudice to the defendant will be presumed absent a demonstration by the party seeking the amendment that there is in fact no prejudice”.[^11] There would certainly have been nothing preventing the plaintiff from seeking to increase its claim earlier. On the other hand there are eight months until the trial, the discovery of the plaintiff has not concluded and expert reports have not yet been delivered. The litigation risk to both parties is increased if the amendment is granted but I am unable to infer irreparable prejudice.
[26] It was suggested that the offeree shareholders would be prejudiced by this massively inflated claim in various ways. Common sense would suggest this will be so. Instead of merely facing the loss of the $40 million escrow fund that was always at risk of adjustment under the terms of the contract, the offeree shareholders will now have to make provision for a potential contingent liability of $610 million. This however is precisely the prejudice they would have faced had the claim been for $650 million in the first place. Since I have no affidavit evidence, there is nothing before me by which I can conclude that they have taken steps in reliance upon the size of this claim that cannot now be undone. While it is possible that a different litigation strategy might have been adopted or will now have to be adopted, that is nothing more than speculation. In the absence of specific evidence, I am not able to find actual prejudice which cannot be addressed in costs or other reasonable terms. Even unfairness is not enough to create prejudice according to the Court of Appeal.[^12]
[27] A finding of abuse of process is ordinarily though not invariably related to a finding of prejudice. Pursuing an aggressive litigation strategy does not rise to the level of abuse of process unless it can clearly be shown to be directed at an improper purpose. Specifically the evidence I would find compelling would be evidence that the amendment would give an unfair advantage to one party over another or was designed to undermine a ruling of the court or the provisions of the rules. I do not have such evidence here.
[28] In summary I am not able to find that the claim is rendered untenable by these amendments nor that the amendments are for an improper purpose nor that the defendants will suffer a high degree of prejudice.
Conclusion and terms
[29] In conclusion the plaintiff has brought itself within the mandatory wording of Rule 26.01 and accordingly leave will be granted to amend the statement of claim in the form proposed.
[30] The court is obliged to address any prejudice to the defendant by an award of costs or by other relief which may be granted consequent to amendments. No such terms of relief were proposed as the defendants were requesting the motion be dismissed but notwithstanding the lack of a fall-back position, it seems reasonable to allow for the possibility that terms should be imposed.
[31] At a minimum the defendants may amend their statement of defence and may discover on the amendments but they may also have to respond to the amendments in other ways. For example I can envision (though it was not in evidence) that due to the vastly increased exposure the offeree shareholders may now have to re-consider cross claims or claims against the former managers. Conceivably some of these decisions could impact on the trial date, could require other adjustments to the timetable or require more substantial relief. The plaintiff will also have to review its productions to ensure it has produced any damage documentation relevant to the increased claim.
[32] The costs of the motion will also have to be decided. As always I invite counsel to agree on costs but otherwise I will hear submissions.
[33] An order will therefore go as follows:
a. The plaintiff’s motion to amend the claim is granted and the amended statement of claim in the form set out at Tab 1 A of the motion record may issue. The amended claim is to be issued within the next 10 days.
b. The defendants may amend the statement of defence and may discover on the amendments. The plaintiff is to advise whether these amendments will require additional production and when a supplementary affidavit of documents can be available.
c. The amended claim is to be issued within the next 10 days. Further direction regarding the timing of the amended statement of defence and any other steps consequent on the amendment will be given at one of the upcoming case conferences.
d. I will hear further submissions if the defendants seek additional terms.
e. I will hear submissions on costs should that be necessary. If either party seeks to make submissions they are to advise my office within 30 days failing which there will be no order as to costs.
Master C. MacLeod
Date: February 21st, 2013
[^1]: 2011 ONSC 4000; 2011 ONSC 7331; 2011 ONSC 7575 (Master); see also 2011 ONCA 125 (C.A.) in related litigation.
[^2]: This includes the warranty that the corporation is not aware of any intention on the part of any of its 10 largest customers to cease doing business with the corporation or to materially change their existing arrangements with the corporation and that there are no material unresolved disputes with its principal suppliers, shippers or customers. (Article 3.01 (12) (k)).
[^3]: Paragraph 6, amended statement of claim
[^4]: The CCAA proceeding has been the subject of much activity on the Commercial List in Toronto. See for example 2010 ONSC 2676; 2011 ONSC 733; 2011 ONSC 5017
[^5]: Paragraph 1 (a), original statement of claim.
[^6]: Paragraph 2 (e), original statement of claim.
[^7]: Rule 26.01
[^8]: The parties both refer to Plante v. Industrial Alliance Life Insurance Company (2003) 2003 64295 (ON SC), 66 O.R. (3d) 74 (S.C.J. - Master) as setting out the test. With respect to abuse of process see also National Trust Co. v. Furbacher [1994] O.J. No. 2385 (S.C.J.) citing with approval C.Evans & Sons Ltd. v. Spritebrand Ltd. and another [1985] 2 All E.R. 415 (C.A.)
[^9]: Plante, supra. See also Chinook Group Ltd. v. Foamex International Inc. (2004) 2004 33017 (ON SC), 72 O.R. (3d) 381 (S.C.J. – Master)
[^10]: Hanlan v. Sernesky (1996) 1996 1762 (ON CA), 3 C.P.C. (4th) 201 (Ont. C.A.)
[^11]: Family Delicatessen Ltd. et. al.v. The Corporation of the City of London et. al. 2006 5135 (ON CA), [2006] O.J. No. 669 (C.A.)
[^12]: See Kings Gate Developments Inc. v. Colangelo (1994) 1994 416 (ON CA), 17 O.R. (3d) 841 (C.A.)