SUPERIOR COURT OF JUSTICE - ONTARIO

COURT FILE NO.: 12-CV-451210
MOTION HEARD: June 20, 2013

RE: 12-CV-451210

Adamson Systems Engineering, Inc. et al. vs. 1173371 Ontario Limited et al.

BEFORE: Master Joan Haberman

COUNSEL:
Matheson, A. for the moving party

Oster, F. for the responding party

ENDORSEMENT

Master Haberman:

[1] The plaintiffs, defendants by counterclaim, (hereinafter referred to as “Systems” ) move for security for costs against the defendant, 1173371 Ontario Limited (hereinafter referred to as “117”) pursuant to subrule 56.01(1)d), on the basis that there is good reason to believe that 117 is a shell corporation lacking in sufficient assets to pay a cost award if so ordered.

[2] 117 has taken an unusual approach in its response. Rather than addressing their ability to pay costs or their inability to post security, they have focused on forum, taking the position that the issue of whether or not they are a shell corporation is a fact to be determined in the arbitration. In addition, they claim that the counterclaim and main action are inextricably bound together, such that only minimal costs will be incurred by Systems in defending the counterclaim. As a result, they submit that no security should be ordered.

[3] In view of the defendants’ approach, I think it best to start with the responses they raised to the issues. If they are correct as regards either of them, this brings the motion to an end.

1. THE TWO BIG ISSUES GOING IN:

a) Is there a complete or substantial overlap between the issues raised by the counterclaim and those already raised in the main action, such that no security should be required?

[4] It is a matter of trite law that a defendant cannot be required to post security for costs to defend his position.

[5] It is also well established that a defendant who is also a plaintiff by counterclaim can be asked to post security for costs with respect to the counterclaim, but only insofar as the counterclaim raises issues that are separate and distinct from those already raised in the main action. Thus, where the plaintiff in the main action will incur additional costs to defend the counterclaim, they can seek security for costs to protect themselves with respect to those additional costs.

[6] Thus, in Wilkings v. Velocity Inc., [2008] OJ No. 1101, the court stated:

A plaintiff by counterclaim can be required to post security. It is a relevant factor in exercising discretion as to whether a plaintiff by counterclaim is required to post security to consider whether or not the counterclaim is in substance a reiteration of the plaintiff by counterclaim’s defence to the main action. If it is, the Court may exercise its discretion to deny the motion by the defendant by counterclaim that the plaintiff by counterclaim post security for costs or qualify the amount of security to otherwise be posted.

[7] In view of 117’s position that there is substantial overlap between the action and counterclaim, such that the latter only increases the plaintiffs’ costs minimally if at all, a detailed review of the pleadings is in order.

The statement of claim – what Systems alleges

[8] In their statement of claim, Systems seeks damages of $35,000 for breach of contract; $100,000 for misrepresentation and breach of fiduciary duties; $25,000 for punitive, aggravated and exemplary damages and an order for an accounting with respect to monies Systems paid to Vandenberg for retraction of the shares of 117. Thus, a total of $160,000 is claimed for damages, along with an accounting.

[9] The following is the context for these claims. Systems is an Ontario corporation based in Port Perry, founded by Adamson in 1992. It is in the business of developing and manufacturing loudspeaker equipment for the professional touring and installation market. Systems is the offshoot of work that Adamson says he began in 1983 in this area, established by him as a means of growing the business.

[10] 117 is also an Ontario corporation, established by the defendant, Vandenberg. in 1996 to serve as a vehicle to raise money for Systems, through which 117’s shareholders could invest in Systems indirectly. Shares in 117 were sold to raise money that was then channeled into Systems.

[11] Vandenberg was, at one time, a chartered accountant. Systems claims that he provided them with financial and accounting advice before, during and after implementation of the shareholder agreements

[12] It is alleged that, unbeknownst to Systems, Vandenberg’s professional licence was subject to an undertaken that he not practice public accounting between December 2000 and June 2002, at which time his licence to practice public accounting was revoked. It is also alleged that Vandenberg suffered from financial difficulties during this time frame and that he was declared bankrupt, another fact that Systems claims they did not know during the relevant time frame.

[13] The defendant, Vance, provided legal advice to 117 and, Systems claims that unbeknownst to them, he was also its sole director. He was disbarred in 2010 for professional misconduct which included deceit, with respect to events that took place in 2007, 2008 and 2009.

[14] Systems claims that the shareholder agreements that are the subject of the dispute were drafted by Vandenberg and Vance.

[15] Systems asserts that Vandenberg was retained to provide advice with respect to orchestrating an infusion of capital. It was Vandenberg who devised this concept of indirectly investment in Systems though another vehicle and it was he who found and dealt with the shareholders, while Adamson remained at a distance. Systems claims that they left it to Vance and Vandenberg to ensure that their interests were advanced and protected.

[16] Although Systems takes the position that these agreements were poorly drafted, they maintain that they reflected the intention of the parties, which included the following:

• The ability for investors to exit at any time and recover 100% of their investment plus amount based on sales (“retraction”); and

• Systems’ right to buy out the investors i) by returning 100% of their investment and ii) by paying them an amount based on improved sales, all outstanding dividends, along with interest penalties and a percentage of retained earnings (“redemption”).

[17] The main financial difference between shareholder- initiated retraction and Systems’ initiated redemption was that, in the latter case, preferred dividends in arrears, along with all penalties, would have to be paid out before the process could take place, whereas they would be forfeited if the shareholders initiated the exit.

[18] In the context of this framework, 117 invested the sum total of $150,000 and in return, received 150,000 preferred shares, deemed class “A” shares, of which Adamson has always held 5,000.

[19] Vandenberg advised Adamson that Systems was required to pay monthly dividends regardless of the company’s financial situation. As a result, Systems periodically paid out dividends, totaling $54,000 by June 2001. Notwithstanding those payments, Adamson was advised that Systems remained in arrears in an amount of approximately $12,000.

[20] Systems claims it is now aware that it was actually prohibited by law from paying dividends during this period as it was it was unable to meet its liabilities, which were being met via loans.

[21] Systems states that its business was affected by “9/11”. They allege that as their revenues declined, Vandenberg became more aggressive about dividends at a time when it was neither possible nor in compliance with the Business Corporations Act for dividends to be declared in view of Systems’ financial position. .

[22] According to Systems, in the spring of 2002, Vandenberg told Adamson that the investors wanted to exit, so the retraction process was initiated. Systems is unequivocal in stating that they did not seek to redeem shares, as they were financially unable to do so. Systems further claims that its debt load was so high that Adamson tried to persuade Vandenberg to abandon the retraction plan but he did not succeed.

[23] Systems now alleges that Vandenberg did not advise Systems well and failed to manage the retraction properly, leading to the current lack of clarity regarding whether what was initiated was a shareholder retraction or Systems’ redemption of the shares. On Vandenberg’s advice, payments of $5,000 per month were made from the spring 2002 until October 2004.

[24] In February 2005, Vandenberg wrote, seeking further payments of just under $50,000. In March, Vandenberg provided Systems with a schedule entitled “Payment of Retraction Amount” and the $50,000 he sought was paid in 10 monthly instalments. By March 2006, Systems had paid out $254,000 on the initial investment of $150,000.

[25] Payment demands continued, and a further $49,000 was paid in November 2009, bringing the total payment to $302,000. According to Systems, this represents an overpayment on retraction of $35,000, such that these monies should be returned to them.

[26] In view of the foregoing, Systems claims that Vance and Vandenberg failed to disclose their conflicts of interest; that they misrepresented themselves as having the skill and expertise to assist his venture and that they abused his trust. Further, despite the payments made over the course of many years, some of the 117 shareholders have never received their share.

Statement of defence and counterclaim – what 117 alleges

[27] 117 and Vandenberg begin their pleading by stating that the court has no jurisdiction over the claim as the shareholder agreements require that disputes are to be resolved by arbitration.

[28] Although served with the claim in April 2012, these defendants chose to defend it and did not seek a date for a motion to challenge the court’s jurisdiction until October 2012, such that the motion to stay the action and have these matters dealt with by way of arbitration was only returnable in mid-July 2013 at the time this motion was argued. I am now advised it has been put over until April 2014.

[29] Vandenberg denies that he was retained to provide external accounting services to Systems as it would have been improper for him to review his own administrative work. He also claims that none of the work he did perform for Systems required him to be licenced under the Public Accountancy Act as his work and that of his staff was limited to providing bookkeeping and administrative services.

[30] Vandenberg asserts that his professional services were no longer needed when Systems hired their own bookkeeper in late 1998, such that the last work of this nature that he performed as part of the transition was completed by February 1999. He therefore denies that he had any duty to advise Adamson of any changes to his accounting status thereafter. I note that, though Vandenberg takes issue with the allegations in the claim regarding the status of his licence, he does not appear to have moved against the claim in that respect.

[31] Though Vandenberg claims he never invoiced for the work he performed after June 30, 1998, he also says that he kept track of his time and estimates that he is owed in excess of $83,000 for professional services. He claims that he was no longer prepared to carry Systems without substantial payment thereafter.

[32] Vandenberg also denies that he provided the first draft of the shareholders agreements, alleging that this was done by Vance and that he then commented on it. He also explains that Vance appears at the first director of 117 as he was their incorporator. Vance resigned from that position in July 1996 and Vandenberg was appointed as an officer and the sole director of 117 at that time.

[33] Vandenberg also deals with Systems’ financial status. He claims the initial infusion of capital sought in 1996 was not to grow the business as alleged but was needed as Systems was already insolvent and unable to obtain further bank funding. He alleges that Adamson approached him in an apparent state of desperation as a result. Vandenberg claims that it was Adamson’s continued purchase of machinery and equipment without long term financing in place that caused the company to become insolvent again by the close of fiscal 1997.

[34] In view of Systems’ precarious financial position, Vandenberg states that he agreed to forebear from time to time regarding the timely payment of dividends. Despite that, Vandenberg alleges that Adamson paid dividends to himself.

[35] I note that 117’s pleading is not an easy one to navigate, hence, it is not always clear what they intend to say with precision. At times, instead of making a positive assertion, they deny what has been alleged by Systems with respect to the issue without actually stating their own position. Some paragraphs go on for half a page or longer, with lengthy and detailed explanations of terms and events. I point this out only by way of explanation for the fact that summarising their position was by no means a straightforward task.

[36] The pleading becomes even more cumbersome when we reach the discussion regarding redemption and retraction. Cutting through the evidence pleaded, it appears that Vandenberg denies that the shareholders ever sought to retract their shares notwithstanding that he provided Systems with what he referred to as a retraction schedule.

[37] Rather, he claims that Adamson wanted to redeem shares and that Systems had been putting money aside for this purpose. Vandenberg states that he therefore assumed that once all dividend arrears and interest had been paid, Systems would deliver a formal redemption notice. They never did and 117 now says they waived this formal requirements of a notice. These defendants claim that as Adamson continued to make payments, all parties acted as though Systems was redeeming the shares in a modified transaction. This term is not explained.

[38] By way of alternative, 117 pleads that there was neither redemption nor retraction, so there is no agreement to repurchase shares as the parties were never ad idem. As a result, he claims no money is owing to Systems at this time.

[39] While conceding that, in this alternative scenario, 117 was overpaid in dividends in the amount of $83,513, these defendants go on to plead that as there was no buy back of shares, there has been an ongoing obligation to continue to declare dividends at the rate of $1,000 per month.

[40] 117 also claims a set off for Vandenberg’s professional services owing since 1999 in the amount of $107,048 plus interest, along with $10,000 that he claims to have personally advanced.

[41] The defendants wrap up with boiler-plate defences. They claim the action was initiated after the expiry of the applicable limitation period and they put the plaintiffs to proof of their damages.

[42] We then come to the counterclaim, which is advanced in an unusual way. Instead of setting it out in the pleading, these defendants state that if the action is allowed to proceed, they rely on the facts alleged and relief claimed in their Notice of Arbitration, attached as a schedule to the pleading. It is therefore essential to review that document, as well, in order to assess the degree of overlap between the main action and the counterclaim. What becomes apparent in short order is that the counterclaim imports a series of new and complex issues to the mix.

[43] In contrast to the relief set out in Systems’ statement of claim, in their notice of arbitration, 117 seeks declarations, inter alia, to the effect that 117 still holds the 1,500 shares in Systems and that Systems is in breach of the shareholders agreements as it has failed to declare dividends since July 4, 2008. In other words, the focus of the counterclaim is not the alleged redemption of shares but rather, an ongoing relationship between the parties with further debts having been incurred by Systems in the form of unpaid dividends.

[44] In that context, 117 seeks an accounting of the dividends owing or, in the alterative, a declaration that the parties entered into a redemption agreement. In the further alternative, damages of $1 million are claimed. The Notice of Arbitration therefore reverses the order as between main and alternative relief that 117 pleads in its statement of defence.

[45] Adamson is named as a defendant in the Notice, and it is alleged that though the shareholder agreements allow him to draw a salary of $50,000 per year, subject to being granted an increase by all a vote of shareholders, he unilaterally decided to pay himself more. 117 claims that he increased his draw by taking a bonus of $50,000 in 2007; that he has also taken interest-free loans; and that he uses one or more corporate vehicles. These are all new issues, raised by the counterclaim, that go well beyond what has been pleaded in the main action and the defence to it. The counterclaim is about what 117 claims is owed to them, rather than being a response to Systems’ claim regarding what 117 owed to Systems

[46] 117 also alleges that Systems has made non-interest-bearing loans to related corporations controlled by Adamson in an amount in excess of $ 1 million. This, too, raises a host of new issues for exploration that go well beyond those raised in the main action.

[47] 117 has tried to wrap these issues into System’s allegations in the main action regarding the shareholders’ desire to be bought out. 117 asserts that the parties will have to deal with all payments due as between them before redemption is possible. However, as the defence to the main action raises only improper payment of dividends by Adamson, these additional issues involving other assorted wrongful payments to Adamson and interest free loans to his other corporate vehicles fall beyond the main action and defence and are features of the counterclaim, only.

[48] I am therefore satisfied that, though both the main action and the counterclaim will require an accounting to be conducted to assess who owes who how much, depending on whether the transaction is determined to be a retraction or a redemption of the shares or a non-event, such that dividends are in arrears, the counterclaim raises new and significant areas, involving a large sum of money, that will also have to be explored as part of that analysis. It will increase both documentary and oral disclosure by Adamson personally, in terms of his personal finances and other holdings that go well beyond the allegations in main action and the statement of defence. In my view, the counterclaim considerably expands on the issues set out in the main action, such that Systems and Adamson will necessarily incur additional costs dealing with it.

b) How likely is it that the action will be stayed in favour of the matter proceeding by way of arbitration?

[49] 117 asserts that the issue of whether or not it is a shell corporation is a fact to be determined at arbitration so that it cannot be used as the basis for this motion.

[50] 117 is correct in the first half of their assertion. Whether or not they are a shell corporation is a fact that remains to be determined. However, it is not necessary that assertion to be resolved and found as fact in order for Systems to pursue an order for security for costs pursuant to Rule 56.01.

[51] As stated in Hallum v. Canadian Chiropractic College (1989) 1989 4354 (ON SC), 70 OR (2d) 119, and by many cases that have followed it, Rule 56.01 provides a two- part test. The onus is on the moving party to begin with and the extent of what they must prove is not defined in absolute terms. Thus, Systems is not required to prove that 117 is a shell corporation and that it lacks sufficient assets to pay a cost order if so ordered. All they have to demonstrate is that there is good reason to believe that this is the case. Once the moving party meets its burden, the onus shifts to the responding party, who must convince the court that the just order in their case is to order that no security for costs is required. They can do so in a number of ways.

[52] Systems has established that there is good reason to believe that 117 is a shell corporation, in that their evidence indicates that the company was created solely as a vehicle through which funding would be raised for Systems. 117’s own evidence supports this thesis and they have filed no evidence which effectively resists the finding.

[53] In their evidence, in large part derived from the cross examination of Vandenberg, Systems has raised concerns as to where the money paid out as dividends has gone, none of which have been answered by 117.

[54] On that basis, it appears that there is good reason to accept that 117 is a shell corporation. On the basis of the test in Hallum, the onus now shifts to 117. 117, in turn, has done nothing to dispute that this appearance is an accurate one.

[55] Instead, 177 has tried to meet its onus by claiming that the action will likely be stayed. I am in no position to decide that issue or the likelihood of whether 117’s position is the correct one. Entering into that debate in any significant way would exceed my jurisdiction. Nor is it appropriate for me to try to predict the outcome of that debate without the benefit of evidence or submissions on this issue. That is for the judge to decide next April.

[56] Right now, I must deal with the action as I find it, structured as a civil action, before the court. In the event that 117’s position prevails on a motion to stay based on the arbitration clause in the agreement, any order I make regarding security for costs will become null at that time and any security posted will have to be paid out.

[57] Having decided both of these issues in favour of Systems, I now turn to 117’s onus and the extent to which it addressed it.

2. HAS 117 MET or EVEN ADDRESSED ITS ONUS UNDER RULE 56.01?

[58] In that Systems met its initial onus on the motion, 117 is now put to the test of showing the court why it would be just in the circumstances of the case to make no order for security for costs in this case.

[59] However, they appear have made no attempt to do that, relying, instead, on the two points raised above. They have filed no evidence regarding their financial situation, so do not rely on an assertion that they do have sufficient assets in the jurisdiction to meet a cost order if one is made, or claim that they are impecunious. They have also failed to delve into the merits of the case to establish what a just order would be, though, admittedly, they would not get far with that kind of submission at this early stage of the litigation.

[60] Accordingly, I find that the just order in this case is one that requires 117 to post security for costs.

THE ORDER and COSTS

[61] I have already issued my Order (July 3, 2013) with respect to the substantive issues. I did so without Reasons at that time as the stay motion was imminent at that time and I believed it was important to have this issue resolved beforehand. That motion has now been put over to next year.

[62] Costs are payable to Systems, as they are the successful party. This is the kind of motion that could have been very straightforward. In view of how they presented their case, however, 117 added layers of complexity to it. They ought to have agreed to post security and then negotiated the quantum to be posted at various stages.

[63] At the end of the day, in view of the proportion of the overall costs that have been and will be expended on the counterclaim, and the fact that security is generally posted on a pay-as-you go basis, the award was a relatively small one at this time.

[64] However, I do not accept 117’s submissions to the effect that this should reduce the costs ordered on the motion. The lion’s share of those costs were incurred with respect to the issue of liability for having to post security and that, in turn, is the result of how 117 approached the motion. As a result, that aspect of the order actually applies to all security for costs that may ultimately be ordered over time, rather than simply the $8,000 ordered now. I see no basis for reducing costs as a result. If this issue becomes moot because the action is stayed and sent on to arbitration, then 117 will save itself the costs of further “top up” motions. If the action continues before the civil court, future hearings will, I hope, involve quantum, only, so this is Systems’ only opportunity to recover costs expended with respect to the issue of liability

[65] According I order costs to the moving parties, fixed at $12,000, payable within 30 days

Master Joan M. Haberman

Released: August 7, 2013