Koubi v. Hascalovici, 2015 ONSC 4132
NEWMARKET COURT FILE NO.: CV-11-104426-00
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
Rom Koubi and 1355863 Ontario Inc.
Plaintiffs
– and –
Avi Hascalovici and Michael Averbuch
Defendants
Mark Klaiman, for the Plaintiffs
Jamie VanWiechen, for the Defendants
HEARD: May 25, 2015
JUDGMENT
charney J.:
Introduction
1This case is a cautionary tale for friends who think that friendship, trust, and optimism can replace written contracts when conducting business.
2The plaintiff, Rom Koubi, and the defendant, Avi Hascalovici, were long-time friends. Koubi was the managing director and sole shareholder of Proment1 – Project Management Inc. (Proment), a corporation incorporated in Ontario, with its head office in Toronto. The other director was Koubi’s wife.
3Proment was primarily involved in the industrial automation industry, but Koubi had also been involved in the design and manufacture of powder compacting presses with his father, Shimon Koubi, in Israel. These “powder presses”, which compacted powdered metal, could be used to manufacture precision metal parts, such as gears, with fewer steps and greater accuracy than the decades-old technology then in use. Shimon Koubi was designing, manufacturing and selling powder presses in Israel and Europe (one had been sold in Switzerland), and his son, Rom Koubi, hoped to introduce this technology into the North American market.
4While Proment was involved in the automation industry, Koubi found automation to be a crowded industry with slim profit margins. It was the technological innovations offered by the powder presses that Rom Koubi hoped would distinguish his company from the competition. Koubi and Hascalovici became “50/50” shareholders in Proment, an enterprise that lasted just over a year.
5In the end, no powder presses were ever sold by Proment in North America and the company lost a great deal of money. In this case, Koubi and Proment allege that Hascalovici had agreed to be responsible for fifty percent of the company’s debts, and are suing him for breaching this alleged agreement. They are also suing Hascalovici’s father-in-law, Michael Averbuch, for breaching an alleged agreement to lend money to Proment. Hascalovici counter-claims against Koubi, alleging that he entered into the partnership on the basis of negligent misrepresentations made by Koubi regarding the technology rights of Proment, and that Koubi has unfairly disregarded Hascalovici’s rights as a shareholder in the company.
Background
6Koubi and Hascalovici shared a mutual interest and expertise in industrial automation, and had worked together informally as friends. Around June of 2009, Koubi and Hascalovici began to discuss the possibility of Hascalovici working as a “self-employed contractor” for Proment. These discussions evolved over the next month, so that by early July they were discussing entering into a partnership agreement to work together at Proment. Hascalovici was, at that time, employed as a program manager at a manufacturing firm called “Multimatic”, and Koubi and Hascalovici saw opportunities for Proment to provide automation services for Multimatic. An email, dated July 6, 2009, from Koubi to Hascalovici, states, “I wanted you to know that I could definitely use a partner and I could not think of someone better to take that position, so please let’s work it out to the benefits of both of us.” They met in July to discuss this proposed partnership, and in August 2009, Hascalovici became a partner with Koubi in Proment, although there was no written “partnership” agreement.
7By October 2009, Hascalovici was writing to website developers and introducing himself as “Rom Koubi’s partner at Proment” and on October 26, 2009, Hascalovici resigned from his job at Multimatic to work full time at Proment.
8In November, the new partners emailed their lawyer to obtain standard shareholder agreements and a “shareholder agreement checklist” to review. Koubi and Hascalovici met twice in February 2010, along with their wives, who were also long-time friends, and the four of them discussed the elements of the shareholder agreement that they saw in the checklist and agreed to certain terms. Both Koubi and Hascalovici testified that they had questions about certain parts of the checklist, but they soon became preoccupied with the business end of their enterprise and never nailed down a written shareholder or partnership agreement. They each also testified that they were concerned that certain terms of the standard agreement were irrelevant to their business and they concluded that the cost of legal expertise could be used more productively on marketing the new business. Accordingly, neither a partnership nor a shareholder agreement was ever signed.
9Notwithstanding the lack of a signed agreement, there is no dispute that they intended to proceed as 50/50 “partners” in Proment, dividing evenly the profits and liabilities of the company as they proceeded. While no shares were ever issued, both Koubi and Hascalovici agreed that they each owned half the shares of Proment. It is also agreed that Hascalovici was added as a third director of Proment. Although they did not have signed agreements, contemporaneous minutes were kept of all their “shareholder” meetings (usually by Koubi’s spouse) beginning in February 2010. Both Koubi and Hascalovici agree that these minutes are generally accurate, although they do disagree on how some of the more cryptic references are to be interpreted. These minutes constitute the primary evidentiary source of what transpired at their meetings.
10By December 2009, the partners were working on a quote to win a contract with Hascalovici’s former employer, Multimatic. As they worked on this proposal, they realised that Proment needed some capitalization in order to win contracts. Prospective purchasers would want to see evidence that Proment had money in the bank and the financial ability to manufacture a powder press in the event that one was ordered. In January 2010, the partners agreed that Koubi would approach his in-laws, who owned an insurance and financing company called FTIC, for a short-term loan. The original idea was that the loan would remain in Proment’s bank account for a few weeks until early February; by then the Multimatic deal would either be won or lost and the loan would be repaid to Koubi’s in-laws.
11At that time, Proment shared office space with FTIC. Koubi asked his mother-in-law for a loan of $120,000. The amount of $100,000 would remain in Proment’s bank account to show prospective clients financial liquidity and $20,000 would be used to pay off Proment’s existing debts. FTIC had access to a line of credit, and lent Proment the money on January 25, 2010. That loan agreement was between Proment and FTIC, and was signed by Koubi as president of Proment, and his mother-in-law, the Senior Manager of FTIC. No personal guarantees were provided by either Koubi or Hascalovici.
12Certain terms of that agreement are significant for the purposes of this case. Firstly, the repayment term of the agreement (Article 4.1) stated: “the Term Loan shall be repaid hereunder on the 21st day of December 2029.” Second, Article 5 stated that “the term loan shall not bear any interest during the loan term”. Notwithstanding Article 5, both Koubi and Hascalovici testified that Proment agreed to reimburse FTIC for the cost of interest payments that FTIC had to pay to borrow this money on its line of credit. This agreement is confirmed in subsequent shareholder meeting minutes, and Proment’s general ledger indicates that Proment made such interest payments to FTIC while Hascalovici was still an active partner in the company.
13Notwithstanding the intention to return the money borrowed as soon as the Multimatic contract was won, the partners realised that, once the contract was signed, they needed the money to actually run the company until they received payments from Multimatic. As a result, the money was not returned to FTIC, but was used by Proment to pay for marketing, a salary for Koubi and Hascalovici, a salesman’s salary, and assorted other expenses.
14The first of the shareholder meeting minutes is dated February 5, 2010. The meeting had two purposes: to discuss a marketing plan and to hammer out the terms of the shareholder agreement. The primary focus of these discussions was the marketing plan for 2010 and the possibility of hiring two employees, one to manage the “powder metallurgy division” and one for sales (the sales employee was in fact hired around the beginning of April, 2010). Consideration was given to looking for a larger space, but this was “tabled to a future date pending receipt of job.” For the purposes of this litigation the two significant discussions in the meeting minutes relate to “sales” and “shareholders agreement.”
15Under the heading “Sales”, the minutes state that the proposed sales for 2010 were to be “Tech center – 10%, Manufacturing environment – 10%, Powder Compacting – 40% focus for 2010, Automation – 40% focus for 2010. Rom and Avi to create a cost spreadsheet for the building of a 12-30 ton [powder] press.” This statement is used by the defendant, Hascalovici, to emphasise the importance of the powder compacting aspect of the nascent business, a point that becomes significant to the defendant’s allegation of negligent misrepresentation.
16Under the heading “Shareholders Agreement”, several points are set out which provide an indication of the elements that the partners did agreed to. The first is that “Rom and Avi [and not their spouses] will only be on the agreement”. The second was an agreement to purchase key person insurance on Rom and Avi, with Proment as the payer and beneficiary of the insurance. The third stated: “Avi Hascalovici and Rom Koubi 50%/50% shareholders”. The fourth stated “Obligations: Both responsible for 100% of the business equally.” There is some disagreement as to what this fourth statement meant. Koubi took the position that it refers to equal responsibility for finances, but Hascalovici took the position that it referred to responsibility for work rather than finances. There is certainly no suggestion here, nor anywhere else in these minutes, that either partner thought that he was giving a personal guarantee for all of the corporation’s liabilities. (Although Koubi had given a personal guarantee on a $20,000 line of credit before Hascalovici joined the company).
17A similar issue arises on the next page under the heading “Financing”, which states: “The shareholders are required to give equal loans to the corporation.” Nothing in this statement quantifies the amount of such shareholder loans or refers to a personal guarantee for loans from third parties, such as the FTIC loan made only two weeks before this meeting. While both parties made financial contributions to Proment, none of these contributions were in the form of loans from either Koubi or Hascalovici. It appears that Koubi was of the view that this provision required each of the partners to arrange a loan from their respective in-laws, as Koubi had done when he persuaded FTIC to lend $120,000 to Proment. Koubi expected Hascalovici to reciprocate at some point and arrange for Hascalovici’s father-in-law, Michael Averbuch (the second named defendant) to lend Proment money. There is evidence that Hascalovici did promise to approach Averbuch for a loan should more money be needed by Proment. While the possibility of a loan from Averbuch was discussed by the partners, the phrase “The shareholders are required to give equal loans to the corporation” is not a contract that the shareholders’ in-laws will lend money to the corporation. While both shareholders did write cheques to Proment, these cheques were not part of a loan agreement.
18A second meeting was held on February 24, 2010, with their lawyer, who took notes of the meeting. This meeting ironed out the final terms of the shareholders’ agreement. There is no reference in these notes to shareholder guarantees or the assumption of personal liability on the part of the shareholders. Again, given the significance of such a departure from the standard arrangement one can assume that their lawyer would have recorded this if it had been discussed or agreed upon.
19The next event of significance occurred on March 3, 2010, when Rom Koubi received an email from his father, Shimon Koubi, in Israel. The purpose of this email was to clarify the relationship between Proment Israel and Proment Canada. Hascalovici testified that when he entered the partnership with Koubi, he did so on the understanding that Proment Canada owned the rights to the powder press technology, had the right to manufacture the powder compacting press in North America, and that Proment Canada would receive the profits of all North American sales. These were the profits that were to be divided between the partners. Hascalovici’s understanding came from Koubi’s representations about the powder press component of the business and the relationship between Proment Israel and Proment Canada.
20The March 3, 2010 email was in Hebrew and received by Rom Koubi at Proment’s Toronto office, where Koubi and Hascalovici sat in facing desks. Koubi testified that he read the email and translated it line by line to Hascalovici. Hascalovici testified that he does not read nor understand Hebrew, and believed that Koubi’s translation covered only some parts of the text rather than the entire email. Regardless of how much was actually translated, both testified that Koubi, as he translated the text, told Hascalovici that he did not agree with certain passages of the email and, as Koubi testified, there were “a few things I wanted to get revised with my Dad.” Indeed, the email stated: “The following document is points for discussion and communication.” On this basis, it was reasonable for Hascalovici to understand that the terms of the email were not the last word, but could change after the discussion between Koubi and his father. Hascalovici was not given a written translation of the email until a translation was prepared for the purposes of the litigation. There was no discussion as to whether Hascalovici agreed with the terms set out in the email.
21The email clarified the relationship between Proment Israel and Proment Canada. It was clear that Shimon Koubi was concerned that his son’s business arrangement could result in the family losing control of the powder press technology which he described as his “career’s flag ship” and “the summary of all my experience and my major activities in the past few years.” Shimon Koubi advised Rom that “It was easier for me to address the contract between us if the company was owned only by you from [sic] the understood reasons.”
22The email set out 24 “key points” including:
(a) The product called the “Powder Compacting Press” is in the ownership of Proment Israel;
(b) Proment Canada will be the exclusive sales representative of the Proment Israel in the North American continent with regards to the powder compacting equipment and will receive 20% commission in return to its efforts to promote the sales and to perform the installation, technical support and training…;
(c) Any mechanical change that will be done on the presses, inclusive of redesigning the press, is the responsibility of Proment Israel and at her consent only…;
(d) In addition to the 20% sales commission, Proment Canada will perform programming tasks that will carry extra compensation based on a quote provided before the initiation of the job, subject to competition by other software programmers. Proment Canada will have the priority in such competition in the condition of meeting the timelines;
(e) In the event of a press sale in North America, the mechanical part of the press will be made in Israel, including the hydraulic unit, or in a place that Proment Israel will decide. The electrical panel will be made in Canada. The final integration will be done mainly in Israel in order to send a “working” press unless otherwise decided…;
(f) In conclusion, in the event of a press sale in North America, Proment Canada will receive 20% commission on the sale, 8% commission on each component purchased, and all the labor involved; and,
(g) Rom [Koubi] is the owner of the rights, their use and the sales of the powder compacting presses. In the event where the partnership in Proment Canada will deem to be dissolved, none of the rights written herein will be transferred to Rom’s partners in such dissolution. Rom will remain the sole owner of those rights. Rom’s partners are not permitted to do [sic] any use with the information or rights.
23Hascalovici testified that these conditions were inconsistent with his prior understanding of the rights of Proment Canada and the relationship between Proment Canada and Proment Israel. In particular, he had understood that Proment Canada had the right to manufacture the powder press, not just sell it on a commission basis as the agent of Proment Israel. This understanding is borne out by the minutes of the February 5, 2010 shareholder’s meeting, which state that “Rom and Avi to create a cost spreadsheet for the building of a 12-30 ton [powder] press.” There was no reason to create such a cost spreadsheet if the partners did not anticipate that Proment Canada would manufacture a powder press. Koubi testified that they had never discussed who owned the technology associated with the powder press, and that, in any event, as long as Koubi remained a shareholder and partner in Proment Canada, Proment Canada would have access to those rights.
24Whatever he might have thought of the March 3, 2010 email, on March 10, 2010 Hascalovici provided Proment with a cheque for $7,000. There was no “loan agreement” accompanying this cheque, which was simply deposited into Proment’s account. This was intended to be his initial financial contribution to the corporation. The money was to be used to establish a website for Proment, and Hascalovici assumed responsibility for working with the web designer on this project. This was the only money from his own funds that Hascalovici contributed to the corporation.
25On May 25, 2010, Proment signed a lease agreement to lease a larger premises commencing June 15, 2010, although the premises were not ready on time, a point that became significant when the Proment ran into financial difficulties in August.
26By August 2010, Proment was burning through money. It received a payment of $22,375 from Multimatic on July 15, 2010, but on August 4, 2010 had only $685 in its bank account. The next payment from Multimatic (approximately $24,000) was not due until September 15. Even though Proment still had a line of credit for $20,000 (of which Koubi was the only personal guarantor), Koubi asked Hascalovici to ask his father-in-law, Averbach, to provide the loan that Hascalovici had previously promised to seek. The evidence is that Hascalovici explained that Averbach’s money was not readily available and could not be provided immediately. Instead of borrowing on Proment’s line of credit, Koubi again approached his in-laws for another short-term loan until Averbach’s loan could be advanced. On August 5, 2010, a cheque from FTIC for $50,000 was deposited in Proment’s bank account. There is a dispute as to whether Hascalovici was present when the cheque was given to Koubi by his mother-in-law, but there was, in any event, no loan agreement to accompany this cheque or any written personal guarantee. Koubi testified that this was because he thought that Averbach’s loan would be coming in the next day or so, and the money could be returned to FTIC. Hascalovici testified that once the FTIC cheque was deposited he advised Averbach that the pressure was off and the loan was not needed “now”.
27The next shareholder meeting took place the very next day, on August 6, 2010. I agree with Mr. Koubi’s counsel that the timing of this meeting was not a coincidence, and that it was arranged precisely because the partners, or at least Koubi, still thought that the infusion of money by Averbach was urgent so that he could repay the loan to FTIC.
28The August 6 meeting was divided into two phases. The first phase was attended by Koubi and his wife, Hascalovici and his wife, and Koubi’s mother-in-law, who had just lent the $50,000 from FTIC. Averbach was not invited to this part of the meeting. The first note on the minutes of the meeting is the question “Did we grow too fast?” Another question recorded in the minutes is whether Shimon Koubi was “ready to invest $75,000 in the press until it is sold?”
29The meeting reconvened that evening at 9:00 p.m. Also in attendance were Koubi’s father-in-law, and Hascalovici’s in-laws, Michael and Ella Averbuch. This was Michael Averbuch’s first formal meeting with the directors of Proment. After reviewing their monthly expenses and the cost of leasing the new building, the minutes indicate that Averbuch had a number of questions regarding the powder press aspect of the business. His questions were answered by Koubi, who explained that Proment Canada did not own the patent, but it was a joint venture with Proment Israel. He stated that Proment Canada had a “right of first refusal” and that it is the “intention of Proment Israel as Shimon Koubi retires patent rights will go to Proment Canada.” He stated that if a powder press was sold in North America, twenty per cent of the profit on the sale would go to Proment Canada, with additional profit if Proment Canada built the hydraulics. Counsel for the defendants points out that this description was not entirely accurate. It is unclear what the “right of first refusal” refers to, but no such right is referred to in Shimon Koubi’s email of March 3, 2010. Secondly, the March 3 email indicates that, upon Shimon Koubi’s retirement, the patent would go to Rom Koubi personally, not Proment. This distinction was not significant to Rom Koubi, but was significant to Mr. Averbuch, who was being asked to lend money to Proment.
30The August 6 minutes then contain the following note: “appropriate breakdown 40% to Proment Canada 60% to Proment Canada.[sic]” Clearly one of these references to “Proment Canada” should have read “Proment Israel.” Likely the second, although it does not matter because this was not the division of profits that Shimon Koubi had offered, but rather appears to be Rom Koubi’s aspiration. This is confirmed by the final notation in the minutes, which everyone agrees was stated by Michael Averbuch: “Need to be clear on the division of profit between Proment Canada and Proment Israel. No clear breakout of profit. How much in royalty. How much is split b/w Proment Canada and Israel?” In addition, the minutes indicate that Averbuch raised concerns about the mounting debt and lack of sales, and stated “show me the tangibles to do a risk assessment.”
31The minutes summarize further discussions about the continuation of the business. These included the need to have a facility to show prospective clients and a proposal to continue the business with December 30 as the “final yes/no day.”
32Finally, the minutes state a number of “conclusions”, including the following: “Avi and Rom will split debt 50/50”, “Michael [Averbuch] will share in the money needed”, “Michael recommending to keep place, not for three years without return. Revisit expenses in a few months and then if needed close”. Another meeting was scheduled for the end of September: “At this point we will figure out financial requirements.”
33On September 10, 2010, Hascalovici did sign a personal guarantee for a line of credit with the bank thereby increasing Proment’s line of credit from $20,000 to $50,000, with both Koubi and Hascalovici as guarantors.
34The parties met again on September 23. This time they were joined by Shimon Koubi, who had come to Canada to assist Proment with developing a proposal for another potential contract. Averbuch testified that he came to that meeting ready to lend $60,000 to Proment if his questions were satisfactorily answered and certain other conditions were met.
35The first line of the minutes of the September 23 meeting (which were written by Rom Koubi) state: “Michael will invest 115k based on the 50% agreement.” Koubi testified that this was Averbuch’s opening statement. According to Koubi, the $115,000 represented half of Proment’s debt at that time – the $170,000 lent by FTIC and assorted other debts totalling $230,000. In contrast, both Hascalovici and Averbuch testified that Averbuch did not make this statement. Hascalovici testified that this opening statement was made by Rom Koubi and not by Averbuch. Averbuch testified that he never stated that he would invest $115,000. He had only ever considered lending $60,000. Given its place as the first item in the minutes, the dollar amount stated, and the context in which the statement appears (prior to the presentation of the budget plan), and given the concerns raised by Averbuch at the August 6 meeting, I find that this statement was more likely an opening proposal by Koubi and was not a commitment made by Averbuch. In making this finding, I want to emphasize that all of the witnesses tried their best to use the often cryptic notes in the shareholder meeting minutes to refresh their memories and piece together their recollections of these emotional events. To the extent that there are any inconsistencies, I do not believe that any witness was not credible, and my findings are based on logic and inference rather than credibility.
36In addition, all agreed that the final bullet in those minutes was Shimon Koubi’s explanation regarding the relationship between Proment Israel and Proment Canada: “agreement between Proment Israel is with Rom Koubi and he is the sole owner of the right to use the technology and cannot be shared with the partners. Sales and exclusivity is included in the agreement.” This explanation, while consistent with Shimon Koubi’s March 3 email to Rom, was not consistent with what Rom had told Averbuch at the August 6 meeting and, according to Averbuch, caused him to reconsider his willingness to make the $60,000 loan.
37The next shareholders’ meeting was held on October 4, 2010 at 8:30 p.m. Averbuch attended this meeting. He testified that he was ready to lend the $60,000, but he first raised a number of “concerns.” He understood from Shimon Koubi’s explanation at the previous meeting that Proment Canada’s income from the sale of powder presses would be approximately 24% (this was a blended figure taking into account the 20% for all sales and additional 8% for component sales). He suggested that the partners dismiss the salesman they had hired in April and keep the space they had leased because Rom Koubi and Haskalovici could do the sales work, but they required an office to show prospective clients. Averbuch agreed to lend “money” (no figure is stated in the minutes), but he wanted more “involvement” and had several conditions. Koubi was unhappy with Averbuch’s position, and he walked out of the meeting to cool off. He returned at 11:10 p.m., and the minutes (written by Koubi) set out Averbuch’s lending conditions: he wanted Koubi and Hascalovici to meet with each other daily and he wanted to meet with the partners on a weekly basis to be given “a review and forecast of the business.” Koubi and Hascalovici would have to decide whether to cut the building or the salesman or both. The last bullet in the note is “Provide Michael with current owing plan for next 16 days for a cheque.”
38The parties agree that no “owing plan” was ever produced or provided to Averbuch.
39Only four days later, on October 8, 2010, the shareholders met again. This time only Koubi and Hascalovici and their spouses were in attendance. Koubi began the discussion by stating that “The company is not in a good place so we need to dissolve the partnership.” He stated that “the terms [of the loan proposed by Averbuch] were not acceptable.”
40The minutes then record the following statements by Hascalovici’s spouse. Both Koubi and Hascalovici confirmed the accuracy of these minutes:
(a) partnership 50/50 for equal payments regardless of what happens
(b) the loaners not committed to each other
(c) never discussed that Michael would match dollar for dollar
(d) Michael [Averbuch] not interested in being against the company, he understands that time is needed to make this company successful
(e) Michael wants that everyone’s expertise to help guide and give from a different angle some feedback
(f) Michael is giving the money in full faith but he wants to try to help as well
(g) Everyone is much wiser now from a quote perspective
(h) He [Averbuch] is not asking for a record to the last penny, he just wants the money to be thought over. If he didn’t think he could trust you [Koubi] and Avi [Hascalovici] he would just say forget about it.
41Koubi stated that his in-laws were upset that there had not been an equal input of financing, to which Hascalovici replied that the issue of funding had to be reconsidered, given the change in the “structure of the return on investment for the press” described by Shimon Koubi at the previous meeting. Hascalovici’s spouse stated: “Obviously, we would pay the interest on the loan”, and Koubi stated: “All the stuff that comes in will be used to pay down the debt.”
42The partners then discuss their options. All agreed that the salesman would have to be dismissed. They considered two alternatives: “flatling” the company or paying everything off and splitting the partnership. The second option would entail: “50/50 debt split. 50/50 split of our future profit on any business initiated together, after all expenses and debts are paid.”
43The next shareholders’ meeting was held on October 23, 2010. By this point, Hascalovici had concluded that given the relationship between Proment Canada and Proment Israel, there was no real role for him in the company. The right to manufacture the powder press was what distinguished Proment Canada in the industry, but Proment did not own that right and would act as a commissioned sales agent of Proment Israel. Without the powder press rights the company would not be profitable. Koubi is recorded as stating, “We need to bring in approximately $40,000 to close everything off” and Hascalovici replied, “Regardless of which scenario we would have to pay that money.” Koubi testified that the $40,000 figure did not include the amount owed to FTIC. Hascalovici indicated his intention to leave the company by the middle of November because he had to start looking for work as soon as possible. They agreed to meet again in a few days “to figure out what the debt is, what jobs are left, rental of the place, etc.” Hascalovici never returned to work at Proment after this October 23 meeting.
44On October 28, 2010, Koubi emailed a spreadsheet to Hascalovici, setting out Proment’s debt, which totaled $214,900. Of this, $170,000 was the loan from FTIC. The balance was made up of various debts including items such as the salesman’s salary ($2,347), rent ($2,896) and computer leases ($13,021). The email indicated that Hascalovici’s share was $107,450.
45Having no response from Hascalovici, Koubi emailed him again on December 3, 2010, stating: “I’m sure you understand that I hold you accountable for 50% of any expenses that business encounter due to decisions made before your departure until those expenses are no longer existing.” Hascalovici’s response (the next day) did not deny liability for his share of the debt, but proposed a follow-up meeting for later in December. Hascalovici acknowledged that he spent at least ten hours reviewing Koubi’s spreadsheet to determine if the calculations were accurate. Koubi’s counsel argues that Hascalovici would not have spent this time to review the spreadsheet unless he thought that he was personally liable for one-half of Proment’s debt.
46On December 15, 2010, Hascalovici sent Koubi an email identifying nine issues with Koubi’s spreadsheet. These issues amounted to approximately $75,000 worth of disputed debt, including Visa charges, website cost, car expenses, accounting discrepancies and accounts receivable. He did not take issue with the loan from FTIC as a specific debt.
47On December 17, 2010, there was a final shareholder meeting between Koubi and Hascalovici. They were joined by their respective spouses, Koubi’s in-laws, and Hascalovici’s father-in-law, Averbuch. They had a detailed discussion of the nine issues raised in Hascalovici’s December 15, 2010 email. Some of these issues were resolved (Koubi either agreed to subtract the item from the debt or explained why they were included), others were left unresolved. This resulted in a reduction of the $214,900 debt calculated by Koubi at the end of October, but other costs had arisen since that date, so the total debt, as calculated by Koubi after that meeting, was still approximately $217,000 ($108,000 each).
48It was at this meeting that Averbuch first proposed the solution of bankruptcy for Proment. If Proment declared bankruptcy, he suggested, FTIC could write off the debt as a bad loan. This option was rejected by Koubi’s in-laws. The last bullet note of the meeting states: “Irit [Koubi] asked when will the payment be made but no date was confirmed.”
49On January 5, 2011, Hascalovici formally resigned as a shareholder and director of Proment. The next day, he gave written notice to the bank that he was terminating his personal guarantee for Proment’s $50,000 line of credit which he had signed in September 2010. This move had the effect of immediately freezing Proment’s bank account.
50Finally, on March 7, 2011, FTIC sent a letter to Koubi and Hascalovici at Proment seeking immediate repayment of the two loans advanced by FTIC to Proment on January 25, 2010 ($120,000) and August 5, 2010 ($50,000). No legal action has been taken by FTIC against Proment to recover this money. Given the written terms of the January 25 loan to Proment (the loan did not become due until December 2029), and the complete lack of written terms in relation to the August 5 loan (although Koubi and his mother-in-law testified that it was intended to be a short-term loan for a few days), the Defendant questions the validity of this repayment letter.
Analysis
Claim against Hascalovici
51From the plaintiff’s perspective this case involves two former friends who agreed to be equal partners in a business. They agreed to share the profits and liabilities on a 50/50 basis. The intent of that agreement, he claims, was to assume personal liability for the debts of that business. To get the business going the plaintiff borrowed $170,000 from his in-laws. The defendant’s in-laws, despite promises, contributed nothing. The business failed, producing only debt, and now, the plaintiff claims, he and the defendant are honour-bound to repay his in-laws (and any other creditor) on the 50/50 basis agreed.
52While in one sense, that is what happened, it is not what happened in a legal sense. From the defendant’s perspective he and his former friend agreed to be equal shareholders in a corporation. That corporation borrowed $170,000 from another corporation. Neither friend signed a personal guarantee for that loan, nor, according to Hascalovici, was there any intention to assume personal liability for the debts of the corporation. The corporation is in debt, but the shareholders are not personally liable for any debt or obligations of the corporation. If the debtor corporation cannot pay its debt, the creditor may sue the corporation, but the creditor has no claim against him personally. If the debtor corporation is insolvent and unable to pay its creditor, it may go bankrupt.
53The primary issue in this case is whether the shareholders’ agreement between the plaintiff and the defendant imposes a legal obligation on the defendant to reimburse the plaintiff (or the corporate plaintiff) for fifty percent of the corporation’s debt. To answer that question, I must consider the nature of the agreement between the plaintiff and the defendant, the terms of that agreement (and whether the terms are ascertainable), and the extent of the liability established on the basis of those terms.
Nature of the Agreement
54To begin with, I find that the Koubi and Hascalovici did agree to proceed as 50/50 “partners”2 in Proment, each owning half the shares of the corporation. As equal shareholders, they did agree to divide evenly the profits of the company. What is less clear is what they meant when they agreed to share the debts of the company as the business failed. The agreement at issue is an oral agreement between Koubi and Hascalovici. There is no contract between Hascalovici and Proment, nor any agreement or contract between Hascalovici and the main creditor, FTIC. Indeed, FTIC is not a party to this action.
55Second, whatever its terms, the agreement between Koubi and Hascalovici does not qualify as a “guarantee” within the meaning of s.4 of the Statute of Frauds, R.S.O. 1990, c. S.19. This is significant because the Defendant took the position in oral argument (although it was not specifically pled in the statement of defence) that if the plaintiff’s interpretation of the agreement between the parties was correct, it constituted a guarantee and, as such, is unenforceable because it was not in writing and signed by the defendant as required by s.4 of the Statute of Frauds.
56A guarantee is “a contract to indemnify a creditor upon the occurrence of a contingency – namely the default of the principal”3. To qualify as a guarantee, the promise must be made to the creditor and it must be contingent on the non-performance of another person4. A “promise made to the debtor himself, to the effect that the promisor will pay any debt that may be owed to third party creditor by the debtor” is not a guarantee, nor are “promises made between persons who are liable for the same debt”5.
57Since an agreement to “share the profits and liabilities” is between two shareholders of the debtor corporation and not an agreement with the creditor it does not qualify as a guarantee, s.4 of the Statute of Frauds does not apply,6 and there is no legal requirement that the contract be in writing or signed by the defendant. The fact that the agreement between the parties does not qualify as a guarantee, however, raises the question of what the agreement actually meant, and whether the parties really had any agreement on this issue at all.
58It is a “basic principle of corporate law… that shareholders, as such, have limited liability. In the absence of a personal guarantee given by a shareholder, a shareholder in his capacity as such is not liable for any act or liability of a corporation because the corporation is a separate legal entity.”7 Indeed, the very reason why creditors often demand personal guarantees from shareholders is to pierce the corporate veil and hold the shareholders personally liable for the debt (or other guaranteed obligation) “in the event that the company cannot honour the debt”8.
59Did the agreement between Koubi and Hascalovici signify an intention to pierce the corporate veil and assume personal liability despite the limited liability they otherwise enjoyed? Part of the difficulty in determining the parties’ intentions in this case is the cryptic and often incomplete nature of the oral agreement as reflected in the minutes and the fact that the parties to the agreement may not have fully understood the legal nature of their arrangements. For example, the minutes often speak of the “partnership” between Koubi and Hascalovici, yet the agreement does not qualify as a “partnership” as that term is used in s. 2 of the Partnership Act9, which expressly excludes “the relation between the members of a company or association that is incorporated.” Indeed, the reference to the equal division of profits and liabilities would make sense if this were a partnership and subject to s.10 of the Partnership Act, which provides: “every partner in a firm is liable jointly with the other partners for all debts and obligations of the firm incurred while the person is a partner…”10
60Part of this confusion can be explained by the fact that the initial discussions between the parties began as a proposed “partnership”, but soon evolved into a “shareholder’s agreement” by the time the terms of the agreement were finally settled in February 2010. In that regard, discussions prior to the February shareholders’ meetings must be approached with some caution.
61It is clear that both Koubi and Hascalovici understood that by proceeding as shareholders in a corporation they were limiting their personal liability. While the parties initially discussed a partnership in July 2009, Koubi was already carrying on business through Proment, which was a corporation. Koubi had already signed a personal guarantee for a $20,000 line of credit with the bank. At that time he knew that his personal liability for the debts of Proment was limited to $20,000.
62In November 2009, the parties requested a draft shareholder agreement from their lawyer. Over the next few months, the parties reviewed and considered this draft agreement. While the draft agreement was never signed by the parties, and does not form part of their agreement, paragraph 6.04 of that draft provided the standard form: “The Shareholders further agree that no Shareholder shall be obligated at any time to enter into any agreement of guarantee with respect to any indebtedness of the Corporation or pledge his or her credit on behalf of the Corporation.” When the parties met on February 5, 2010 to consider the future of their business and hammer out the terms of their agreement, there was no discussion of this draft term or an indication that either party proposed to depart from this standard form. Nor was there was any discussion of the principle of limited shareholder liability or an indication that either party proposed to depart from that principle. In my view, the minutes of the February 5 shareholders’ meeting, together with the record of the meeting with their lawyer on February24, are the closest thing that the parties have to an agreement. I have examined the terms disclosed in these records at paras. 16 to 18 above, and I have concluded that there is no suggestion anywhere in these records that either party thought that he was departing from the standard form of limited corporate liability and agreeing to be personally liable for all of the corporation’s debts and liabilities. Given the significance of assuming personal liability, I would expect to see any such assumption of personal liability stated in unequivocal terms before I would find that it was a term of the agreement (Fritz Marketing Inc. v. Metz, 2014 ONSC 5924, at para. 36).
63The closest the February 5 minutes come to personal liability on the part of the shareholders is the statement that “the shareholders are required to give equal loans to the corporation.” This term was taken from the shareholders’ agreement checklist that had been provided by their lawyer. It does not impose personal liability on a shareholder beyond the value of the loan. As indicated above, both Koubi and Hascalovici gave money to Proment, although these cheques were not accompanied by a loan agreement. Koubi appeared to believe that the loan from FTIC to Proment qualified as a loan from him to Proment because his in-laws owned FTIC. But Koubi is not FTIC, and this loan from FTIC would not satisfy this particular obligation.
64Nor is there anything in the record of the February 24, 2010 shareholders’ meeting with their lawyer that addresses the issue of shareholders’ guarantees or personal liability. In my opinion, the minutes of the February 5 and February 24 meetings constitute the totality of the terms of the shareholders’ agreement. Any discussions prior to these meetings were provisional and subject to final agreement at the February meetings, any discussions following these meetings are discussions without the benefit of legal advice in which the parties struggled to figure out what to do with their floundering enterprise. They should not be taken as amending the terms of the shareholders’ agreement unless they expressly purport to do so.
65It is also significant that the first loan from FTIC to Proment was made on January 25, 2010, which was prior to the finalization of the shareholder agreement between Koubi and Hascalovici in February 2010. In January 2010, the parties had not yet met to review the draft shareholders’ agreement and the terms of their agreement remained inchoate. This factor also tends to contradict the plaintiff’s position that by January the parties had already decided to waive their limited liability and assume personal liability for that loan.
66My view that no personal guarantee/liability was agreed to by the parties is also confirmed by the conduct of the parties. When Proment’s bank account dwindled to only $685 on August 4, 2010, Koubi borrowed an additional $50,000 from FTIC rather than borrowing on Proment’s $20,000 line of credit with the bank. I can only infer that he preferred to borrow from FTIC rather than the bank because he did not have a personal guarantee with the former. Further, Proment’s line of credit was increased to $50,000 when Hascalovici finally signed a personal guarantee in September 2010. Proment could have used this credit to pay back at least some of the money to FTIC, but this would have resulted in personal liability for both Koubi and Hascalovici. It appears to me that both Koubi and Hascalovici conducted themselves in such a way as to limit their personal liability in a manner consistent with s.92(1) of the OBCA, and preferred to borrow from FTIC, where they had not provided a personal guarantee. There is, of course, nothing wrong with that, it is why s.92(1) of the OBCA is there. It may, however, become a problem when a shareholder’s legal obligations are different from what he perceives to be his family obligations. In this case, Koubi, to his credit, feels a family obligation to repay his in-laws, even if neither he nor his former friend has a legal obligation to do so.
67Counsel for the Plaintiffs points to the undisputed fact that when Hascalovici was presented with the spreadsheet outlining the accounting of Proment’s debts on October 28, 2010, he did not deny liability for that debt, but poured over the details to try to reduce his share. I have no doubt that at that time Hascalovici thought that he was liable for fifty percent of the debt of Proment. It was not until he discussed this issue with his more experienced father-in-law in December 2010 that he fully understood that, as a shareholder, he might not be legally responsible for the debts of the corporation. The issue before me, however, is not whether Hascalovici thought he was liable for this debt, but whether the terms of the shareholders’ agreement imposed that liability. Liability derives from the terms of the contract, not from a party’s incomplete or inaccurate understanding of the applicable legal principles.
68Finally, counsel for the plaintiff points to the unfairness of the defendant’s willingness to assume his share of the profits (had there been any), but deny his share of the debt. That position, however, is consistent with the principle of shareholders’ limited liability. It is also worth noting that the nature of the “profits” changed from Hascalovici’s original understanding. When Hascalovici left his job at Multimatic and became a fifty percent shareholder of Proment, he understood that Proment Canada’s profits would include the entire profit from the sale and manufacture of powder presses in North America, and he would get fifty percent of that. He later discovered that Proment Canada’s profits from the powder press would be limited to a commission of approximately twenty-four percent from the sale of powder presses in North America which would be manufactured in Israel. The balance of the profits would go to Proment Israel, which was owned by Koubi and his father, and would be owned 80% by Koubi when his father retired in two years.
69Accordingly, I conclude that the shareholders’ agreement between Koubi and Hascalovici did not impose personal liability on the parties to that agreement for the debts and liabilities of Proment, and neither Koubi nor Hascalovici are personally liable for the outstanding indebtedness of Proment. It follows that Hascalovici has not breached his agreement with Koubi.
Claim Against Averbuch
70The plaintiff claims that Averbuch agreed to lend funds to Proment and breached his agreement by failing to do so. In the alternative, the plaintiff’s claim against Averbuch is on the basis that he made representations that he would advance funds to Proment, and that Proment and Koubi, in reliance on those representations, which were untrue, entered into further debt than they otherwise would have. For example, Koubi alleges that he could have cancelled the lease in September 2010 because the leased space was not ready on time, but claims that he did not do so because of Averbuch’s promise of a loan. He claims that he could have saved approximately $7,500 had he known by August that Averbuch was never going to provide the loan.
71Based on the evidence reviewed in this matter, I conclude that Averbuch did offer to lend funds to Proment, but not until October 4, 2010, and his offer was contingent on certain conditions that were either not agreed to by Koubi or not fulfilled by Proment or its shareholders. There was, however, no agreement or promise prior to October 4.
72Averbuch attended four shareholders meetings: August 6, September 23, October 4 and December 17. At the first of these meetings, Averbuch had a number of questions regarding the powder press aspect of the business. While Koubi provided answers, some of these answers were not accurate. In any event, Averbuch was clearly not satisfied with the information he was given because the minutes note his continued concern: “need to be clear on division of profit between Proment Canada and Proment Israel. No clear breakout of profit.” In this regard it appears as though Koubi’s inaccurate answers were not relied upon by Averbuch, who still had more questions, in addition to the concerns he raised about the mounting debt and lack of sales, and his request that he be shown “the tangibles to do a risk assessment.” I conclude that at the end of this August 6 meeting Averbuch was still considering a loan of $60,000 to Proment, but that no commitment or promise was made.
73The September 23 meeting was the one also attended by Shimon Koubi, who gave Averbuch an accurate explanation of the relationship between Proment Canada and Proment Israel. I have already found that this information caused Averbuch to reconsider his intention to lend $60,000 to Proment, and, in any event, no commitment to lend money was made at that meeting.
74The third meeting attended by Averbuch was on October 4, 2010. It is undisputed that Averbuch offered to lend $60,000 to Proment at this meeting, but he outlined several conditions, including weekly meetings with Koubi and Averbuch, and a “current owing plan for next 16 days for a cheque.” It is also undisputed that this “owing plan” was never provided to Averbuch, and that at the shareholders’ meeting of October 8 (which Averbuch did not attend) Koubi indicated that the terms of the loan proposed by Averbuch “were not acceptable.”
75The final meeting attended by Averbuch was the final shareholders’ meeting of December 17, which focused on calculating Proment’s debt. There is no suggestion that the issue of a loan from Averbuch was discussed at this meeting.
76Based on the foregoing I conclude that there was no agreement between Averbuch and Proment, or between Averbuch and Koubi, whereby Averbuch had promised to lend money to Proment. The discussions leading up to the October 4 meetings appear to be negotiations and fact finding by Averbuch, and Averbuch’s offer on October 4 was rejected by Koubi and/or Proment, or the pre-conditions for the loan were not fulfilled. Since there was no agreement, or the pre-conditions of the agreement were not fulfilled by the plaintiffs, the claim against Averbuch for breach of agreement must fail. Nor did Averbuch make representations that he would advance such funds (apart from the offer made on October 4), and so the claim for misrepresentation must also fail.
Counterclaim
77Hascalovici’s statement of defence also includes a counter-claim against Koubi for breaching his obligations under the OBCA by refusing to wind-up or place Proment into receivership despite the fact that Proment is insolvent and unable to pay its creditors. Hascalovici claims that this conduct by Koubi has “oppressed” Hascalovici and has unfairly disregarded his interests as a shareholder in Proment. This counterclaim was not vigorously pressed during the argument of the case, and I took it to really be a defence in the event that I concluded that Hascalovici was personally liable for Proment’s debt. In the absence of such personal liability on the part of Hascalovici, there can be no claim that Koubi’s refusal to wind-up or place Proment into receivership is in any way oppressive or unfair to Hascalovici.
Conclusion
78Accordingly, the claim is dismissed as against both defendants and the counter claim by Hascalovici is also dismissed. If the parties cannot agree to costs, costs submissions should be made in writing of no more than ten pages each. The defendant may file their costs submissions within thirty days of this decision, and the plaintiffs may have fifteen days to reply.
Mr. Justice R.E. Charney
Released: June 25, 2015
The company is at law a different person altogether from the subscribers to the memorandum and, though it may be that after incorporation the business is precisely the same as it was before and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or a trustee for them. Nor are the subscribers as members liable in any shape or form, except to the extent and in the manner provided in the Act.
Footnotes
- Proment was also known as 1355863 Ontario Inc.
- This is the term used in the minutes and emails of the parties, although, as explained below, the corporate arrangement does not qualify as a partnership under s.2 of the Partnership Act, RSO 1990 chap. P-5.
- McGuinness, The Law of Guarantee, (1986), at pp. at p. 29.
- The Law of Guarantee, supra, at pp.28-30, 130.
- The Law of Guarantee, supra, at pp. 34, 37, 129.
- The Law of Guarantee, supra, at pp.115, 117-120, 129-130.
- Adams, Annotated Ontario Business Corporations Act, p.A-27, commenting on s.92(1) of the OBCA. The statutory exceptions to s.92(1) set out in that section are not relevant to the analysis of this case. See also: Salomon v. A. Salomon & Co. [1897] A.C. 22(H.L.), at 51:
- The Law of Guarantee, supra, at p. 11
- RSO 1990, chap.P-5
- See also s.24 – 1 of the Partnership Act, which provides that, subject to an express agreement to the contrary: “All the partners are entitled to share equally in the capital and profits of the business, and must contribute equally towards the losses, whether of capital or otherwise, sustained by the firm…”.
