Pilch et al. v. TemboSocial Inc. et al.

[Indexed as: Pilch v. TemboSocial Inc.]

Ontario Reports

Ontario Superior Court of Justice,

D.M. Brown J.

September 25, 2014

122 O.R. (3d) 270 | 2014 ONSC 5590

Case Summary

Corporations — Oppression — Remedies — Parties to application for oppression remedy consenting to trial of issue of value of applicants' shares — Respondent majority shareholders consolidating their position as result of court-ordered purchase of applicants' shares — Minority discount not applied to valuation of applicants' shares — Court concerned in these circumstances with fair market value of shares rather than with their market value.

The applicants owned 25 per cent of the shares of the company, and the individual respondents owned the remaining 75 per cent. When the company dismissed the male applicant, he brought an action for damages for wrongful dismissal. The applicants also commenced an application for an oppression remedy under the Canada Business Corporations Act, R.S.C. 1985, c. C-44. In the oppression application, the parties consented to a trial of the issue of the value of the applicants' shares.

Held, the parties' experts were directed to prepare revised valuation opinions.

It would be inappropriate to apply a minority discount to the valuation of the applicants' shares. A minority discount reduces the price attached to minority shares because they do not represent control of the corporation. Where, however, a court directs the compulsory purchase of shares by existing shareholders who thereby consolidate their existing shareholdings -- such as in dissent, appraisal, winding-up and compulsory purchases under the oppression remedy -- the rationale for a minority discount does not apply. In such circumstances, the court is concerned with the fair market value of the shares rather than their market value.

The impact of any liability of the company for the continuing wrongful dismissal claim should be recognized in the calculation/payment of the value of the [page271] applicants' shares, not in a reduction of any award or settlement amount for the wrongful dismissal claim.

Diligenti v. RWMD Operations Kelowna Ltd. (No. 2), 1977 393 (BC SC), [1977] B.C.J. No. 1331, 4 B.C.L.R. 134 (S.C.), apld

Other cases referred to

Brant Investments Ltd. v. KeepRite Inc. (1987), 61 O.R. (2d) 469, [1987] O.J. No. 2700, 43 D.L.R. (4th) 141 (H.C.J.); Cholakis v. Cholakis, [2010] M.J. No. 153, 2010 MBQB 116, 253 Man. R. (2d) 101, 72 B.L.R. (4th) 120; Irwin v. D.W. Coates Enterprises Ltd., 1983 629 (BC SC), [1983] B.C.J. No. 2026, [1984] 2 W.W.R. 231, 49 B.C.L.R. 383, 1983 CarswellBC 372, 24 A.C.W.S. (2d) 11 (S.C.); Mason and Intercity Properties Ltd. (Re) (1987), 1987 173 (ON CA), 59 O.R. (2d) 631, [1987] O.J. No. 448, 38 D.L.R. (4th) 681, 22 O.A.C. 161, 37 B.L.R. 6, 4 A.C.W.S. (3d) 307 (C.A.); Rendle v. Stanhope Dairy Farm Ltd., [2003] B.C.J. No. 2880, 2003 BCSC 1894, 22 B.C.L.R. (4th) 77, 41 B.L.R. (3d) 295, 128 A.C.W.S. (3d) 493; Zeller Estate v. Canada, [2008] T.C.J. No. 325, 2008 TCC 426, 2008 D.T.C. 4441, 168 A.C.W.S. (3d) 1106

Statutes referred to

Canada Business Corporations Act, R.S.C. 1985, c. C-44 [as am.]

TRIAL of an issue of the valuation of shares.

C. Skipper and M. Graves, for applicants.

G. Benchetrit, for respondent.

D.M. BROWN J.: —

I. Share Valuation Trial

[1] TemboSocial Inc. is a software company specializing in solutions for companies to propel connections, conversation and community with employees, managers and customers. The applicants, Lawrence Pilch and Rhonda Feldman, own 25 per cent of the company's shares (the "Pilch shares"). The individual respondents, Steven Green and Anne Green, own the remaining 75 per cent. The respondent Steven Green is the company's sole director.

[2] In November 2011, the company dismissed the applicant Lawrence Pilch. Two legal proceedings resulted. First, on May 24, 2013, Pilch brought a wrongful dismissal suit against the company. A few days later, on May 29, 2013, Pilch and his wife commenced this application seeking various relief under the Canada Business Corporations Act, R.S.C. 1985, c. C-44.

[3] The parties negotiated a consent order for the trial of an issue which was embodied in the September 24, 2013 order of Newbould J. (the "consent order"). That order required the preparation of audited financial statements of the company for the year ended December 31, 2012 and the six-month period ended [page272] June 30, 2013. Once those were prepared, para. 3 of the order required that

there shall be a trial of the issue of the value of the shares of the applicants in the Corporation as of June 30, 2013, and that this court will determine the value of the applicants' shares to be purchased by the respondents, pursuant to paragraph 6, below (the "Share Value Issue").

Paragraph 6 of the order stated:

THIS COURT ORDERS that, upon determination by the court of the share value issue, the respondents, Stephen Green and Anne Green (or one of them), shall purchase the shares of the applicants in the Corporation at the value determined by the court, and pursuant to a transaction structure to be agreed by counsel, or as directed and under the supervision of this court.

[4] Counsel entered into a letter agreement dated September 23, 2013, which dealt with several issues concerning the trial of the share value issue. Paragraph 1 of the letter dealt with the minority discount issue and stated:

[I]t is agreed that the respondents, Stephen Green and Anne Green, are permitted to advance the argument that the value of the applicants' shareholdings should receive a minority discount, which issue is in contest, and the applicants are permitted to argue that no minority discount can and/or should be applied to the applicants' shareholdings.

The letter also contained an agreed-upon transaction structure for the sale of the Pilch shares following determination of the share value issue.

II. The Expert Valuation Evidence

[5] On consent, the evidence at trial was limited to testimony by expert valuators. The applicants submitted valuation reports prepared by, and called at trial as a witness, Mr. Wayne Rudson of RVG Valuations Group Inc. Mr. Rudson prepared an April 23, 2014 report determining the fair market value of the Pilch shares, as well as a May 23, 2014 report reviewing and commenting on the respondents' expert valuation report. Also, an addendum report dated June 26, 2014 addressing one issue was filed on consent at the trial.

[6] The respondents filed reports prepared by, and called at trial, Mr. Bruce Roher of Fuller Landau LLP, who prepared a comprehensive valuation report dated April 2, 2014, which was amended by a report dated May 23, 2014, and who, as well, prepared a limited critique report dated May 23, 2014.

[7] By letter agreement dated June 26, 2014, counsel advised the court that they had accepted the credentials of the respective experts and the step of qualifying the experts would not be required for trial. Accordingly, I accepted both experts as [page273] qualified to give opinion evidence on the fair market value of the Pilch shares, a conclusion I would have reached in the absence of counsel's agreement given the obvious qualifications of both Mr. Rudson and Mr. Roher to give expert valuation evidence.

III. Points in Agreement Between the Expert Valuators

[8] Both experts agreed on certain fundamental points:

(i) both attempted to determine the fair market value of the Pilch shares;

(ii) both agreed on the definition of fair market value -- i.e., the highest price, expressed in terms of money or money's worth, obtainable in an open and unrestricted market between informed and prudent parties, acting at arm's length, with neither party being under any compulsion to transact;

(iii) both agreed that they had prepared their opinions on the basis that no specific third-party purchaser had been clearly identified for the Pilch shares;

(iv) finally, both agreed that the appropriate valuation methodology was a going concern approach. Robson employed a capitalization of earnings approach; Roher used a capitalized cash flow approach. Although there are certain technical differences between those approaches, both experts agreed that the approaches were substantially the same.

[9] In broad terms, both experts undertook the following exercise:

(i) first, they attempted to prepare an estimate of the future maintainable earnings of the company as at the valuation date of June 30, 2013;

(ii) next, they selected and applied a capitalization rate, or earnings multiple, to the estimate of future maintainable earnings;

(iii) third, they attempted to quantify the net amount which should be added to capitalized earnings by reason of the existence of redundant assets of the company;

(iv) the experts then calculated the pro rata value of the Pilch shares of the resulting enterprise value;

(v) finally, Roher calculated a minority discount to be applied to that pro rata value. Rudson, by contrast, stated in his report that he had been instructed not to consider a minority discount. [page274]

IV. Approach to the Differences Between the Experts

[10] Although the experts employed a common methodology, certain material factual differences emerged at each stage of their valuations. As a trial judge, it is open to me to accept the opinion of one expert, or the opinion of the other, or neither. Both experts performed comprehensive valuation exercises. Both acknowledged that the evaluation process involves, at certain key points, the exercise of professional judgment, and some of the material differences between the experts reflected their differing exercise of professional judgment. To a large extent those differences reflected different degrees of optimism about the future of the company.

[11] The valuation approaches employed by both experts were substantially the same, but the earnings versus cash flow methodology inevitably contained some differences in numbers. As a result, I have decided to make findings of fact on the key issues in dispute between the experts in the valuation exercise and I will set out those findings of fact in these reasons. I then intend to direct each expert to prepare a revised valuation opinion, using the methodologies and numbers contained in their expert reports, but incorporating the findings of fact which I will make in these reasons. I will ask the experts to deliver those revised opinions to me, and I will then see what, if any, material difference exists in the resulting valuation of the Pilch shares. I will then release supplementary reasons for judgment fixing the value of the Pilch shares.

[12] The structure of the remainder of these reasons will follow the various stages of the valuation methodology used by the experts in order to identify the material differences between each expert and then make findings of fact on each of the disputed items.

V. Maintainable Earnings

[13] The maintainable cash flow of a company implies a level of earnings which can be reasonably expected in the future. As put by Roher, maintainable earnings should not be construed as a level that will necessarily be achieved in each and every year, but rather a reasonable average expected level. The company commenced business in 2003.

[14] Rudson determined the company's maintainable earnings based upon the financial statements for the fiscal year periods ending December 31, 2010 through to June 30, 2013. Rudson expressed the view that the resulting after-tax indicated maintainable earnings of $397,000 were most representative of [page275] the future maintainable earnings of the company as at the valuation date.

[15] Roher determined the company's maintainable cash flow by reviewing the historical operating results of the company for the fiscal years ended December 31, 2009 to 2012, the six-month period ended June 30, 2013 and the annualized financial results for fiscal year 2013. Roher opined that the annual maintainable pre-tax cash flow of the company was approximately $330,000 (after-tax $279,000).

[16] The experts differed on the proper treatment of several components of the company's maintainable earnings, and I will consider each component for which material differences emerged.

A. Professional fees

[17] The company incurs expenses for professional fees, specifically accounting fees and fees paid to staff recruiters. Rudson approached his analysis on the basis that the company expected to incur significant "non-recurring recruiting fees" for 2013 and, as a result, Rudson drew upon the actual professional fees incurred by the company in 2010, 2011 and 2012 to arrive at an amount of $25,000 for estimated annual professional fees. In undertaking his analysis for 2013, Rudson excluded certain accounting fees from the actual January-June 2013 expenses on the basis that they would not be incurred again in the last six months of 2013 because they related to work performed for this litigation. Rudson then calculated an annualized 2013 amount for professional fees of $131,709. However, based upon his view that much of that amount involved non-recurring recruiting fees, Rudson made an adjustment of $106,709 to maintainable 2013 annualized earnings in order to get down to his estimated annual professional fees of $25,000 for use in the maintainable earnings analysis.

[18] Roher used the sum of $182,960 as the amount of professional fees against which to adjust for annualized 2013 earnings. The basis upon which Roher arrived at that figure was information provided by management as disclosed in note 12 to Appendix 3 of Roher's valuation report:

Management advised that, on average, the company anticipates to hire/replace 4 staff members annually at an average recruiting cost of $10,000 per employee. The Company's need for technology and other staff has increased in recent years as a result of the rise in the integration and one-off projects. The recruiting cost of $10,000 appears reasonable based on our review of the Company's G/L.

Based on actual professional fees of $91,480 for the first six months of 2013, Roher projected annualized professional fees [page276] for 2013 of $182,960. He later made an adjustment to economic/ market level of $52,000 for professional fees, consisting of accounting fees of $12,000 and recruitment costs of $40,000.

[19] In his reply report, Rudson noted that Roher's estimate of professional fees was "based on recruiting costs which have not been incurred in previous years".

[20] I am not prepared to accept Rudson's contention that the recruiting costs should be treated as non-recurring in nature. The evidence disclosed that the company incurred actual recruiting costs in the first six months of 2013. Simply because an operating expense had not previously been incurred did not mean the expense would be non-recurring in nature. The need for properly qualified staff is an ongoing business need of any company, and I am not prepared to treat the company's actual 2013 staff recruiting costs as non-recurring in nature.

[21] Nevertheless, on this issue one is entering into the murky realm where valuation is more art than science. For the purposes of estimating the company's 2013 annualized professional fees, I conclude that the amount should consist of $25,000 -- i.e., the historic average of professional accounting fees -- combined with $40,000 for staff recruiting costs. I therefore find that the amount of $65,000 should be used in the maintainable earnings analysis as the amount of the company's 2013 annualized professional fees.

B. SR&ED credits

[22] Over the years, the company had received from the federal government SR&ED credits, and the company had applied for and expected to receive such credits in 2013. Rudson reported that the company had received SR&ED credits in 2011 and 2012 of $117,909 and $199,663, respectively, resulting in an annual average of $158,786. Rudson testified that Green had told him the company would continue to use the same consultant to apply for SR&ED credits in 2013. Rudson used the $158,786 average for the amount of the SR&ED credit the company could expect to receive in 2013.

[23] By contrast, Roher used $90,550 as the 2013 expected SR&ED credit. To arrive at that number, Roher performed an analysis (Appendix 3, note 1) in which he allocated the SR&ED claims into income based on the relationship between the year in which the refund was received and the year in which the qualified expenditure was incurred. In his limited critique report, Roher also stated that in arriving at his annualized 2013 number he had relied on information provided to him by Green that management expected the 2013 SR&ED credit to be less than [page277] 50 per cent of the average of SR&ED credits received in the prior three years. Since Green had a direct monetary interest in the outcome of this trial because he will have to purchase the Pilch shares, I approached such information provided by Green with a great degree of caution. In my view, the more prudent approach is to rely upon the actual historic performance of the company for the purpose of projecting 2013 annualized earnings in light of the undisputed evidence that the company expected to receive some SR&ED credits in 2013.

[24] As a result, I prefer the analysis performed by Rudson which conformed more closely to the pattern of SR&ED credits historically received by the company. Roher's analysis injected an element of distortion into the historic pattern of SR&ED credit receipts and therefore skewed the effort to estimate future maintainable earnings based upon recent past company performance. I therefore find that the amount of $158,786 should be used as the company's 2013 annualized receipt of SR&ED credits for purposes of the maintainable earnings analysis.

C. The weighting of annual/annualized earnings

[25] For the purpose of calculating maintainable earnings, each expert attributed different weights to various fiscal years. Rudson attributed the following weights to 2011, 2012 and 2013 annualized earnings: 1:2:3. By contrast, Roher placed no weight on 2011 earnings, weighing 2012 and annualized 2013 earnings as 1:2 respectively. Two issues arose from those differences.

[26] First, in his May 23, 2014 limited critique report, Roher stated that he did not give any weight to 2011 earnings for two reasons: (i) a declining trend in adjusted maintainable earnings made the company's more recent years more representative of future maintainable earnings than prior years; and (ii) "the discrepancy in the 2011 retained earnings".

[27] The discrepancy in the retained earnings resulted from the company's retained earnings at the end of fiscal 2011 being stated as $1,491,758, whereas the company's stated retained earnings at the beginning of fiscal 2012 were $1,618,983. Rudson testified stated that $110,000 worth of the discrepancy could be explained by the treatment accorded to Pilch's accrued severance pay. Drawing upon the auditor's adjusting journal entries (Ex. 5), Rudson contended that $110,000 of the discrepancy could be explained by the auditors reversing the reversing entry for Pilch's severance accrued in 2011: AJE 16 and AJE 17. Rudson stated that in 2012, the company expensed $110,000 for Pilch who was not working for the company and that amount should be added back for the purpose of calculating maintainable [page278] earnings. At the trial, Roher filed an amended Appendix 3 to his valuation report in which he had added $110,000 in 2012 to the line item, "management/related party remuneration -- Lawrence Pilch".

[28] Accordingly, I accept the explanation which Rudson gave for the difference in the 2011 closing retained earnings and the 2012 opening retained earnings based on the auditor's adjusting journal entries. Indeed, Roher corrected his evidence on this point at trial. Given Rudson's explanation, I conclude that the apparent difference in closing and opening retained earnings, in and of itself, did not constitute a basis upon which to disregard maintainable earnings for 2011 for purposes of a weighting analysis.

[29] As to the second reason advanced by Roher -- the declining trend in maintainable earnings -- his exclusion of 2011 earnings from the analysis resulted in a much narrower data set upon which to calculate future maintainable earnings. Roher only used 1.5 years of actual earnings, with the 2013 earnings annualized; by contrast, Rudson used 2.5 years of actual earnings, with 2013 earnings annualized. In my view, given that the company had been in operation since 2003, the calculation of maintainable earnings should draw on more than 1.5 years of actual results in order to derive a fair average of historic earnings upon which to estimate future earnings. I therefore find that the maintainable earnings calculation should be based on the company's actual results for 2011 and 2012, as well as the annualized results for 2013, with those years weighted on the basis used by Rudson -- i.e., 1:2:3.

VI. Capitalization Rate/Earnings Multiple

[30] Once one calculates an amount for annual maintainable earnings, one then multiplies the result by a factor in order to arrive at a capitalized earnings or going-concern value. Both experts derived multiples or capitalization rates. Rudson calculated and applied an average multiple of 5.5, whereas Roher used an average earnings multiple of 4.8. As Rudson stated in his reply report:

In general, the determination of the capitalization rate requires the application of professional judgment based on a consideration of many factors.

One possible reason for the difference in multiple is a higher level of risk ascribed to the business by Fuller Landau. The RVG Report considers a number of positive factors favoring a higher multiple for TemboSocial, outlined in the revised Exhibit B attached hereto.

An additional reason for the difference is based on the methodology employed by Fuller Landau. The Fuller Landau Report calculates the [page279] weighted average cost of capital for TemboSocial, which has implicit assumptions about the capital structure of TemboSocial including levels of debt which do not exist in the company.

In his testimony, Rudson stated that capitalization rates are an area involving professional judgment in which there is no right or wrong answer.

[31] In s. 9.0 of his valuation report, Roher described in detail the "build-up" methodology which he used to determine the capitalization rate, examining the after-tax cost of debt, as well as the risk-free rate of return, an equity risk premium, an industry risk premium and a size premium for the company. Like Rudson, Roher also identified specific positive and negative factors affecting the company.

[32] Rudson identified the positive and negative risk factors surrounding the company in s. 9.2.1 of his report. In his reply report, Exhibit B, note 1, Rudson identified the discrete elements of his build-up approach, similar to Roher's, which resulted in Rudson's capitalization rate of 18.27 per cent, or a capitalization multiple of 5.47.

[33] Although slight differences existed between the experts in the rates they used for the equity and industry risk premiums, the main differences related to the size risk premium and company specific risk premium. Roher used a size risk premium of 9.74 per cent, whereas Rudson used 5.9 per cent. Roher used a company specific risk premium which ranged from a low of 7 per cent to a high of 9 per cent, whereas Rudson used 3 per cent.

[34] In respect of the size risk premium, Roher selected a premium based on the 2013 Ibbotson SBBI Valuation Yearbook for the smallest subsection of stocks for the years 1926 to 2012 -- the 10b decile. By contrast, Rudson used the micro-cap size premia in the 2013 Ibbotson SBBI Valuation Yearbook. In his limited critique report, Roher wrote:

The Ibbotson Yearbook states that the "Micro-Cap Size Premia" includes the 9th and 10th decile in terms of market capitalization. The 9th decile includes companies with a market capitalization between $254.6 million and $514.2 million. In our view, we do not believe this decile is appropriate with respect to the valuation of TemboSocial.

The Ibbotson Yearbook provides a breakdown of the 10th decile between the "10a decile" and the "10b decile". The 10a decile includes companies with a market capitalization between $166.2 million and $253.8 million. The 10b decile includes companies with a market capitalization between $1.1 million and $165.6 million.

We believe that the 10b decile size premium of 9.74% indicated in the Ibbotson Yearbook is most appropriate in the estimation of size premium applicable to TemboSocial. The inappropriate size premium selected by RVG is a primary contributor to the overstatement of the multiples used in the RVG Report. [page280]

[35] I accept that analysis by Roher. Although the company is a private one, without market capitalization, the experts variously calculated fair market values for TemboSocial ranging from $2.87 million to $3.5 million. Its revenues for the year ended December 31, 2012 were only slightly more than $2.3 million. The size risk premium used by Rudson was not appropriate for an entity the size of the company.

[36] As to the company specific risk premium of 3.00 per cent used by Rudson, I accept Roher's critique that Rudson did not give appropriate weight to the following negative factors: that the significant personal goodwill attributable to Green's role in the company might not be easily transferable to a potential purchaser; the small size of the company's customer base and the customer concentration risk; the downward trend in the Company's revenue stream; an increasing reliance on projects with a lower contribution margin; and the increasing trend of the loss of customers as they adopt platforms which include similar tools to those offered by the company.

[37] Rudson pointed out that the company did not have any interest-bearing debt, which led him to argue that it was inappropriate for Roher to use implicit assumptions about the company's capital structure which included levels of debt. While I understand the point, in my view Roher's use of an optimal capital structure did not materially impact the analysis and, in any event, directionally the impact was to lower the weighted average cost of capital before adjusting for a long-term growth factor.

[38] Consequently, on balance, I accept that the multiples derived by Roher from his weighted average cost of capital findings more reasonably reflected the various risk factors associated with the company than those calculated by Rudson. The midpoint of the multiples derived by Roher was 4.8, and I find that 4.8 is the appropriate multiple to apply against the company's annual maintainable earnings in order to derive the capitalized value of the company before making certain adjustments.

VII. Calculating Redundant Assets

[39] The next step in the analysis is to add to the company's capitalized earnings value the fair market value of any assets owned by the company not employed in its day-to-day operations -- i.e., its redundant assets. On this issue, the experts disagreed about two matters. First, Rudson used a working capital ratio of 1.2, whereas Roher used 1.5. Second, Rudson disagreed with a $348,000 income tax deduction which Roher applied to calculate net redundant assets of $1.588 million. [page281]

A. Working capital ratio

[40] As to the differences in the derived working capital ratios, Rudson stated in his reply report:

The working capital ratio of 1.2 used by the RVG Report was determined using the average working capital ratio for comparable companies from the 2013 -- 2014 Annual Statement Studies prepared by the Risk Management Association ("RMA"). The Fuller Landau report utilized a five-year average per the Ibbotson Cost of Capital 2011 Yearbook. It is our view that the RMA method, in conjunction with our experience, provides the best estimate of typical working capital requirements.

[41] Roher explained the reasoning behind his selection of a working capital ratio in Appendix 7, note 2 to his May 23, 2014 valuation report:

Based on the review of market data for SIC code 7379 (Services-Computer Services, Not Elsewhere Classified) per "Ibbotson Cost of Capital 2011 Yearbook", the five-year average of the current ratio for the companies ranges from 1 to 2 times current assets over current liabilities. We have selected a midpoint of this range (1.5 times current assets over liabilities) in our calculation of the redundant assets. As a result of the discontinuation of the production of the Ibbotson Cost of Capital Yearbook by its publisher Morningstar, the 2012 and 2013 editions of this publication are not accessible. We relied on the five-year average in the 2011 Yearbook to be representative of the current ratio as at the Valuation Date.

We also reviewed the 2013-2014 Annual Statement Studies prepared by Risk Management Association relating to working capital ratios for companies of sales between $1 million and $3 million . . . Based on the above data for 2013/2014, the range of working capital ratios is 1.1 to 2.2, with a midpoint of 1.65.

TemboSocial's business cannot be specifically categorized in one industry classification. Rather, its business is related to aspects of all of the above noted industry classifications. In addition, we note that the ratio of 1.5 is generally consistent with the range of current ratios of the various industry classifications set out above. Accordingly, we are of the view that a working capital ratio of 1.5 is reasonable.

[42] I accept Roher's selection of 1.5 as a reasonable and appropriate working capital ratio. The company's business did not fall into one specific published industry classification, and I consider Roher's treatment of the working capital ratios found in the 2013-2014 annual statement studies prepared by Risk Management Association to be more comprehensive and balanced than that performed by Rudson. The midpoint of 1.65 derived from that review, when considered with the midpoint of 1.5 derived by Roher from the Ibbotson Cost Of Capital 2011 Yearbook, support a finding, which I make, that the appropriate [page282] working capital ratio for the company to be used in the capitalization of earnings approach is 1.5.

B. Distribution taxes

[43] Roher estimated gross redundant assets of approximately $1.936 million from which he deducted approximately $348,000 in distribution taxes. Roher's justification for that deduction was set out in note 2 to Appendix 1 of his valuation report, in which he wrote:

As stated in the Canada Valuation Service (page 5A-109):

"Because the vendor prior to sale, or the acquirer after purchase, may choose to dispose of the redundant assets and extract the proceeds from the company, these assets are generally treated on a liquidation basis. The cost of disposition, such as sales commissions, legal fees, and the income tax consequences relative to the disposition, generally are deducted from the gross proceeds to determine the net realizable value, or the net cash available for distribution to shareholders."

We have considered that redundant assets would attract income taxes at approximately 36% if distributed to an individual purchaser or $Nil if distributed to a corporate purchaser. We have estimated distribution taxes at the midpoint of this range of 18% (Source: Canada Valuation Service, 5A-109, Ian Campbell, Howard Johnson, Christopher Nobes).

[44] Rudson disagreed with the distribution tax deduction made by Roher. In his reply report, Rudson stated:

The Fuller Landau report acknowledges that tax is not relevant if the potential purchaser of TemboSocial is a corporation (rather than an individual). We are of the view that a notional purchaser of TemboSocial would be a corporation for obvious tax, creditor proofing and other reasons, and accordingly tax should not be deducted.

[45] I accept Rudson's analysis. Putting aside who the actual purchaser of the Pilch shares will be in this case -- an irrelevant consideration for the initial step of determining the value of the business as a going concern[^1] -- I find that it is more probable than not that the purchaser of the Pilch shares would employ the most tax-efficient structure utilizing some form of corporate entity, thereby avoiding distribution taxes. I therefore find that an amount for distribution taxes should not be deducted from gross redundant assets. [page283]

C. Treatment of the non-balance sheet assets

[46] In his May 23, 2014 valuation report, Roher included in redundant assets $661,229 consisting of SR&ED credit receivables of $429,194 and certain receivables due from third parties in the amount of $232,035. Roher included those as adjustments to the June 30, 2013 company assets notwithstanding that neither amount appeared on the audited financial statements for the six months ended June 30, 2013. In his limited critique report, Roher stated that he added both current assets in order to adjust upwards the current assets used for the redundant assets analysis, resulting in a starting point of current assets of $3,327,779.

[47] Rudson filed a brief June 26, 2014 supplementary report in which he calculated how the inclusion of the $661,229 in additional current assets would increase the value of the Pilch shares.

[48] No evidence was adduced about why the auditors had not recorded those additional assets in the audited financial statements for the period ended June 30, 2013. However, both experts agreed that the value of the redundant assets should be increased by $661,229. Both parties submitted that the court was not required to make any further findings or conclusions on this issue.

VIII. Minority Discount

[49] The respondents submitted that a minority discount should be applied to the valuation of the Pilch shares. In his May 23, 2014 valuation report, Roher estimated that an applicable minority discount for the Pilch shares would be in the range of 20 per cent to 30 per cent; Roher used the midpoint of 25 per cent. In his reply report, Rudson stated that he had been instructed not to consider a minority discount in arriving at his findings.

[50] A minority discount reduces the price attached to minority shares because they do not represent control of the corporation. Where, however, a court directs the compulsory purchase of shares by existing shareholders who thereby consolidate their existing shareholdings -- such as in dissent, appraisal, winding-up and compulsory purchases under the oppression remedy -- the rationale for a minority discount does not apply. As explained by the Court of Appeal in Mason and Intercity Properties Ltd. (Re):

. . . I am of the view that majority shareholders, who have created an intolerable situation for a minority shareholder sufficient to justify the invocation of s. 247, must, except in unusual circumstances, expect to pay for the shares of the minority shareholder at their fair value without minority discount.

. . . . . [page284]

In my opinion, "intemperate conduct" does not of itself disentitle the appellant to receive the fair value of her shares. Like Nourse J. in Bird Precision Bellows, I believe that, in order to justify the deduction of a minority discount in the valuation of minority shares, the conduct of a minority shareholder must be of such a grave character that he or she deserved to be excluded from the company.[^2]

Courts have expressed the view that in determining the price to be paid to a shareholder who has been wrongly treated, courts should not apply a lower or more disadvantageous formula than that applied when determining the price to be paid to a dissenting shareholder.[^3]

[51] In Mason, the Court of Appeal adopted the following approach to the valuation of shares in a compulsory purchase situation used by the British Columbia Supreme Court in Diligenti v. RWMD Operations Kelowna Ltd. (No. 2):

[W]hile it is true that in the process of the initial step -- determination of the value of the business as a going concern -- one must look at what a willing purchaser would be prepared to pay a willing vendor for that business on the open market, in the second step -- determination of the actual price for the shares, the situation here is quite different from that of a minority shareholder offering his shares on the open market . . . [H]ere, where the purchase will be by virtue of an order that existing shareholders, or the company, make the purchase, the result will be that existing shareholders will simply consolidate their positions. They do not become minority shareholders as a result of the purchase -- they are already, as individuals, minority shareholders; in this case they become holders of one-third of the shares instead of one-quarter. Their position in relation to each other is not changed. On the basis of the facts I consider that the arguments as to the application of a minority discount do not apply to these circumstances.

Second, and more important, I hold that the law as it has been developed in connection with the fixing of the price for shares in situations such as this makes it clear that what the court is concerned with is not the market value of the shares, but with the fair market value or price to be set in the circumstances[.]

This is not an arid distinction, but a real one which recognizes and gives effect to the particular situation where there has been oppressive or unfair conduct which justifies an order that the shares of the minority be purchased by the majority or by the company. Again it is true that the first step in valuation is to determine the value of the business, so far as is possible to do so, on the basis of estimated market value. But when it comes to determining the price to be paid for the shares in these circumstances, the test is not market value of those shares -- where a minority discount would apply -- but what price is fair in the circumstances.[^4]

[Emphasis in original] [page285]

[52] In the present case, the consent order of Newbould J. simply stipulated that there would be a trial of the issue of "the value of the shares of the Applicants in the Corporation". No doubt the consent order did not use the terms "fair value" or "fair market value" -- with their associated implications for using or not using a minority discount -- because counsel wanted to be free at the valuation trial to argue either for or against the application of a minority discount.

[53] The respondents correctly observed that although this share value trial arose in the context of an oppression application commenced by the applicants, no judicial finding of oppression or other misconduct has been made because the parties consented to a trial of the share value issue. However, I do not accept their submission that the facts in this case closely resembled those in Irwin v. D.W. Coates Enterprises Ltd.[^5] because that case concerned the valuation of shares where the company was obliged under the terms of a shareholders' agreement to purchase the shares of a deceased shareholder. No similar or analogous contractual obligation existed in the present case, and although the parties had agreed in s. 7.3(b) of their shareholders agreement to apply a 20 per cent discount where a non-defaulting principal exercised an option to purchase the shares of a defaulting principal in defined events of default, the circumstances covered by that provision did not arise in the present case.

[54] The need for the valuation exercise in the present case arose because one group of shareholders alleged oppression against the other, and both groups quite sensibly agreed to put the merits of that dispute to one side and, instead, address the most important practical question ? what was the value of the [page286] Pilch shares? As a result of that quite sensible decision, the consent order stated that upon the determination of the value of the Pilch shares, the respondents would purchase them. Also, the September 23, 2013 letter agreement between counsel described the transaction structure for the purchase of the Pilch shares by the respondents. So, at the end of this trial, the respondents will purchase the Pilch shares and end up owing all the shares of TemboSocial. Given that context, I conclude that the two-step valuation approach set out in the Diligenti case should apply and that no minority discount should be used to determine the value of the Pilch shares.

IX. Prejudgment Interest

[55] The applicants sought prejudgment interest on the value of the Pilch shares from the valuation date, June 30, 2013, until the date of closing of the share purchase. They argued that in other cases interest on the amount of the share value award made in favour of dissenting shareholders had been granted from the date of appraisal to the date of judgment,[^6] as well in circumstances where shareholders who had engaged in oppressive conduct were required to purchase the shares of other shareholders.[^7]

[56] I accept the submission of the respondents that no award of interest should be made because (i) the issue was not contained in the consent order or counsel's letter agreement, (ii) the applicants only raised the issue on the first day of trial and (iii) such a late advancement of this issue prevented the respondents from adducing evidence about alleged delay by the applicants which could undercut the claim for interest.

X. Effect of the Mr. Pilch's Wrongful Dismissal Claim

[57] I accept the respondents' submission that the impact of any liability of the company for the continuing wrongful dismissal claim asserted by Mr. Pilch should be recognized in the calculation/payment of the value of the Pilch shares, not in a reduction of any award or settlement amount for the wrongful dismissal claim. In my view, the fairest way to proceed is to order that part of the amount due from the respondents in payment for the Pilch shares should be held back as a reserve, in [page287] a lawyer's trust account, pending the final disposition of the wrongful dismissal action.

XI. Costs of the Audit

[58] A CBCA company is required to prepare audited financial statements. TemboSocial has paid for the financial statements ordered. I see no basis upon which to affix the cost of the audited financial statements on individual shareholders.

XII. Summary and Costs

[59] In para. 11, above, I stated that I would direct both experts to prepare revised valuation opinions using the methodologies and numbers contained in their expert reports, but incorporating the findings of fact which I have made in these reasons. I therefore order both experts to exchange and deliver to my attention (Judges' Administration, 361 University Avenue) such revised valuation reports by 12 noon on Monday, October 6, 2014. I am not sitting that week and will be able to release a final decision fixing the value of the Pilch shares during that week. Given the findings which I have made above, it is my expectation that the revised values for the Pilch shares submitted by the experts will not differ materially. I must emphasize that I am not looking for a re-argument on matters already determined. I simply expect the experts to plug my findings into their models and calculate revised share values.

[60] At the same time, the parties should file brief submissions about the appropriate amount to hold back pending final disposition of the wrongful dismissal action by Mr. Pilch. Of necessity, the calculation of any such reserve will possess a certain "rough-and-ready" characteristic. The negotiation by the parties of a sensible consent reserve amount obviously would prove the most reasonable approach. If the parties cannot so agree, I will fix an amount and leave its disposition to the trial judge in the wrongful dismissal action.

[61] If the parties cannot settle the issue of costs, any party seeking an award of costs should serve and file their submissions by 12 noon on October 6, 2014. Responding submissions shall be filed by 12 noon on Friday, October 10, 2014.

[62] It is my intention to dispose finally of all aspects of the proceeding before me by Thanksgiving. No extensions of time will be granted.

[63] I wish to thank counsel for their most helpful written closing arguments; they were a pleasure to read. [page288]

XIII. Post-script: A Practice Note ? Ordering Copies of the Digital Recordings of Trial Evidence

[64] Both sides referred to the evidence led at trial in their closing submissions; both sides advised that they had not ordered the transcripts of that evidence; both sides disputed the accuracy of the summary of some evidence advanced by the other. There was no need for such a dispute. All courtrooms in the Toronto Region are now equipped with a digital recording system. For a modest fee, counsel may purchase CDs containing audio recordings of each day's evidence. Those recordings enable counsel to ascertain precisely what was said by the witnesses at trial. Therefore, absent an equipment failure, there should not be any dispute about who said what during the trial. Ordering copies of the digital recordings is significantly less expensive than ordering transcripts. In my view, it should become standard practice by trial counsel.

Order accordingly.

Notes

[^1]: See the analysis of the Minority Discount issue below, especially the approach set out in Diligenti v. RWMD Operations Kelowna Ltd. (No. 2), 1977 393 (BC SC), [1977] B.C.J. No. 1331, 4 B.C.L.R. 134 (S.C.).

[^2]: (1987), 1987 173 (ON CA), 59 O.R. (2d) 631, [1987] O.J. No. 448 (C.A.), paras. 40 and 48.

[^3]: Diligenti, supra, para. 92.

[^4]: Supra, at pp. 165-66 B.C.L.R.

[^5]: 1983 629 (BC SC), [1983] B.C.J. No. 2026, 1983 CarswellBC 372 (S.C.). The reasoning of Robinson L.J.S.C., in para. 22 of the reasons, disclosed two distinguishing aspects of that case: (i) the acquiring company could well suffer a disadvantage by the requirement to purchase the shares of the deceased shareholder and (ii) "[t]here is no suggestion of oppression". Nor do I consider that it would be fair to follow the result in Rendle v. Stanhope Dairy Farm Ltd., [2003] B.C.J. No. 2880, 2003 BCSC 1894. In that case, the court specifically considered and rejected the allegations of oppressive conduct, which led it to consider the value of the shares within the framework of an alternative to a winding-up order. With great respect to the learned trial judge in that case, I was unable to ascertain the reason for the selection of a 15 per cent minority discount as articulated in paras. 75 and 77 of the reasons. Finally, I did not find apposite the decision of the Tax Court of Canada in Zeller Estate v. Canada, [2008] T.C.J. No. 325, 2008 TCC 426, dealing as it did with the calculation of the value of shares upon a deemed disposition under the Income Tax Act.

[^6]: Brant Investments Ltd. v. KeepRite Inc. (1897), 61 O.R. (2d) 469, [1987] O.J. No. 2700 (H.C.J.), para. 24.

[^7]: Cholakis v. Cholakis, [2010] M.J. No. 153, 2010 MBQB 116, para. 79.

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