Court File and Parties

COURT FILE NO.: CV-16-00562264 MOTION HEARD: 20180917

SUPERIOR COURT OF JUSTICE - ONTARIO

RE: Crossover Health Care Fund, LLC, Plaintiff AND: Pivotal Therapeutics Inc., Defendant

BEFORE: Master J. E. Mills

COUNSEL: C. Sainsbury and G. Splawski, Counsel for the Plaintiff/Defendant by Counterclaim R. Stephenson, Counsel for the Defendant/Plaintiff by Counterclaim

HEARD: September 17, 2018

REASONS FOR DECISION

[1] Both parties have brought security for costs motions. For the reasons that follow, both motions are granted.

[2] The plaintiff, “Crossover”, is a hedge fund located in the United States. Crossover does not dispute that it is not ordinarily resident in Ontario and therefore, pursuant to R. 56.01(1)(a), the defendant, “Pivotal”, is entitled to an order for security for costs. The issue is quantum. Crossover submits that to the extent Pivotal’s counterclaim is distinct from the main action, Crossover should be relieved of the requirement to pay security for costs in respect of the issues raised in the defence which ought to have been more properly pleaded in the counterclaim.

[3] Crossover also seeks security for costs in respect of the counterclaim on the basis that pursuant to R. 56.01(d), there is good reason to believe Pivotal has insufficient assets in Ontario to pay a costs order should it be unsuccessful in the counterclaim.

[4] It is agreed that Rule 56 provides for a two-part analysis and that the test to be applied is as set out by Master Muir in Evolution de Future of Carnival Inc. v. Toronto Mas Band Association, 2012 ONSC 1628. The initial onus is on the moving party to demonstrate that the responding party appears to fit within one the enumerated subrules of R.56.01(1) and that there is good reason to believe that the situation of the party meets the criteria of the subrule. If that is accomplished, the onus shifts to the responding party to demonstrate they are impecunious and that the court ought to make an order that is just in the circumstances, or alternatively to prove they do have sufficient assets in Ontario to satisfy any adverse cost order. The merits of the action will be examined and, where impecuniosity has not been shown, the responding party must satisfy the court that the claim has a good chance of success.

[5] Ultimately, it is the role of the court to make an order that is just, having considered all of the circumstances.

[6] In its counterclaim, Pivotal repeats and relies upon the allegations in its statement of defence. The defence is 21 paragraphs; the counterclaim is three paragraphs, the first being the usual list of damages and orders sought and the last being a claim for set off. There is only one paragraph in the counterclaim which asserts various breaches alleged to have been committed by Crossover and the impact of those alleged breaches on Pivotal’s business operations. The substantive allegations supporting the counterclaim are all contained in the statement of defence to Crossover’s claim for default on a Convertible Promissory Note.

[7] Crossover submits the two actions are separate and distinct. It is suggested the counterclaim is merely a tactical ploy by Pivotal to delay paying a debt obligation. Pivotal submits the actions are intricately intermingled and cannot be considered independent of each other. As a result, Crossover submits it is entitled to seek security for costs of the counterclaim to the extent it complicates and lengthens an otherwise simple action; Pivotal resists on the basis that to make any such order would in effect compel it to post security for asserting a defence to the claim filed by Crossover.

Factual Background

[8] Pivotal is a specialty pharmaceutical company which has developed and marketed medical foods. It was a publicly traded corporation, listed on the Toronto and Vancouver stock exchanges.

[9] Between 2012 and 2013, Crossover invested funds in Pivotal initially pursuant to an equity agreement and then subsequently a debt financing agreement. Between August 2012 and October 2013, Crossover invested $2,741,890 in common shares and warrants of Pivotal. The initial equity agreement called for Crossover to inject $5 million (the “Equity Agreement”). Pivotal understood the funds would be paid in a lump sum but the payments were advanced and accepted in tranches over several months with the last payment made on September 5, 2013.

[10] Crossover then refused to inject any further equity payments, requiring instead that Pivotal enter into a debt agreement if any additional funding was to be made. On October 3, 2013, Pivotal signed a loan agreement supported by a Convertible Promissory Note in the amount of $1,649,280 (the “Debt Agreement”). The next day, the funds were advanced by Crossover to Pivotal. Following this initial payment, Crossover refused to provide any further debt financing to Pivotal. The terms of the Convertible Promissory Note were negotiated and it was eventually signed on March 4, 2014 (five months after the advance of funds) with a maturity date of March 4, 2016. It included a restrictive covenant requiring Crossover’s consent before Pivotal could incur any future debt financing.

[11] Pivotal asserts that Crossover failed to deal fairly and contrary to its representations at the time. It is alleged Crossover deliberately breached the Equity Agreement so as to force Pivotal to sign the Debt Agreement, knowing Pivotal was in a financially vulnerable position at that time. Once the Debt Agreement was executed, Pivotal pleads Crossover then breached that agreement and further wrongfully withheld its consent to any other financing so as to compel Pivotal to breach its obligations under the Convertible Promissory Note.

[12] It is further alleged that Crossover breached its duties of confidentiality, good faith, confidence and non-interference with Pivotal’s economic and business interests by thwarting its efforts to source alternative investment and financing. It is alleged this scheme was perpetrated so as to seize control of the patent portfolio held by Pivotal in respect of their medical innovations.

[13] It is the submission of Pivotal that but for Crossover’s misrepresentations and default of the Equity Agreement, Pivotal would not have signed the Debt Agreement under duress and would not now be in default of that agreement. As a result, it is alleged in both the statement of defence and counterclaim that Crossover’s wrongdoings laid the foundation for the default by Pivotal and has given rise to damages for the loss of its business enterprise.

[14] Crossover submits its claim is a standalone action for the recovery of a debt which Pivotal admits having signed and for which funds were advanced without repayment. Crossover also submits any course of conduct allegations cannot stand as a defence to a Debt Agreement entered into by commercial parties with the assistance of legal counsel; and further, the Equity and the Debt Agreements must be considered in isolation as separate agreements, negotiated at different times and for different purposes.

[15] Pivotal submits both actions must be examined together, in a holistic way, examining all of the circumstances that gave rise to the matters in issue. It is alleged the course of dealing by Crossover led to the events underlying both the claim and the counterclaim.

Analysis and Findings

Pivotal’s Motion

[16] Pivotal is presumptively entitled to security for costs of its defence to the action, including proof of the facts upon which it relies. The history related to the Equity Agreement and the breach of that agreement is alleged to be a critical foundation to the circumstances giving rise to the negotiation of the Debt Agreement. I accept that a holistic analysis of the factual background history to the date on which the Convertible Promissory Note was signed is required for both the defence and the counterclaim. This is the extent to which Pivotal is entitled to security for costs. The balance of the conduct allegations in the relationship history of the parties relate to the counterclaim for which there is no entitlement to a security for costs order.

[17] The damages asserted in the counterclaim are reliant on the facts and the history of the entire relationship between Pivotal and Crossover however, this is not a simple set off claim. The totality of the economic loss arising from the alleged breach of the Equity Agreement is not a defence to Crossover’s relatively straight forward debt action. As a result, Pivotal is not entitled to security for costs in respect of those aspects of the proceeding required to prove the loss of Pivotal’s business enterprise due to the alleged conduct of Crossover and the extensive damages suffered as a result.

[18] The bill of costs submitted in support of this motion by Pivotal seeks a total of $250,272.68 as projected costs for the action in its entirety. In my view, this is excessive and clearly includes fees related to proving the counterclaim. In the circumstances, it would be appropriate to order security for costs on a pay-as-you-go basis in respect of the defence of this action as follows:

• $10,000 to be paid forthwith in respect of the costs incurred to date and through to the completion of examinations for discovery;
• $10,000 to be paid following completion of the examinations for discovery in respect of the costs from that stage of the litigation through to the completion of a pretrial conference;
• $25,000 to be paid following the pretrial in respect of the costs for preparation and attendance at trial.

Crossover’s Motion

[19] Crossover is entitled to security for costs in respect of the counterclaim only if it has established there is good reason to believe Pivotal has insufficient assets to satisfy an adverse cost award. If this onus is met, Pivotal must prove that it would not be just to order security for costs because to do so would otherwise end meritorious litigation. Pivotal must demonstrate the counterclaim has a real possibility of success.

[20] Crossover submits that based on Pivotal’s own evidence, it is conceded the company does not have sufficient assets to satisfy cost order. It is admitted that Pivotal has ceased to meet its obligations to suppliers and other service providers. In a press release dated May 5, 2016 Pivotal publicly acknowledged that it has laid off its employees and does not have sufficient funds to carry on its business. Further, it was acknowledged by Pivotal’s President and CEO that the revenues are so minimal, it currently has insufficient funds to pay rent, phone and operations. These obligations, as well as the litigation, are being personally funded by the principals of Pivotal. They have no legal obligation to continue to do so.

[21] Pivotal submits it has more than sufficient assets and specifically denies it is in any way impecunious on the basis that it has unencumbered assets with a book value of approximately $1,300,000. It is submitted the commercial value of those assets, being the inventory, scientific equipment and intellectual property, by far exceeds the value attributed to them in the financial books and records of Pivotal. Based on the subjective evaluation of Pivotal’s founding principal, the estimated value of the assets ranges from $13,765,000 to $30,765,000, with the intellectual property valued at between $13 million and $30 million.

[22] The question becomes whether this subjective evaluation of assets is sufficient to respond to an assertion that Pivotal has insufficient assets to satisfy any adverse cost order in respect of the counterclaim. It is proper “to consider critically the quality as well as the sufficiency of the assets presently held and whether or not they are bona fide assets of the company.” [671122 Ontario Ltd. v. Canadian Tire Corp., 1993 CarswellOnt 466 (CA)]. There must however, be some limit to the inquiry made into the nature of the assets because the rule for security for costs does not call for an extensive or speculative inquiry as to the future value or availability of those assets as at the time they may be called upon to satisfy a costs order.

[23] There is no evidence submitted by Pivotal as to a current independent valuation of the assets, and in particular the inventory or scientific equipment. The book value of the assets is stated to be in accordance with unaudited, internal consolidated financial statements dated September 30, 2015, which were prepared by management. It was conceded at the time that Pivotal had insufficient funds to obtain audited financial statements. These financial statements are stale dated by more than three years and yet this is the only evidence provided by Pivotal as to the sufficiency of its assets. I am not satisfied this is a fair valuation of the assets presently held by Pivotal or if indeed these assets continue to be bona fide assets of the company.

[24] Further, with respect to the intellectual property, the valuation placed upon it is based on the opinion of Dr. George Jackowski, the author and holder of the patents which comprise the intellectual property asset. Dr. Jackowski holds the patents. Pivotal bases its business on those patents, but it does not own them. Based on the evidence before me, I am not persuaded the intellectual property is an asset of Pivotal that is capable of being liquidated or monetized.

[25] There were no cases cited to me addressing whether the assets must be capable of being liquidated or monetized in order to satisfy a costs order. I am of the view the assets must be exigible in nature. Otherwise, the statutory purpose for the rule would be undermined by a party’s reliance on assets that could never in fact be used to pay an adverse cost order. This is distinct from assets which exist at the time of the motion but are capable of being dissipated or eliminated prior to being called upon for satisfaction of the costs order. In order to be bona fide assets for the purpose of a security for costs motion, they must be of a nature that can be converted to cash or an alternative financial instrument.

[26] As a result, Crossover has met its burden of establishing there is good reason to believe Pivotal has insufficient assets in Ontario to pay an adverse cost order in the counterclaim.

[27] As Pivotal has denied it is impecunious, the analysis must turn to the merits of the counterclaim and whether it has a good chance of success. There must be a “real possibility of success” in order to warrant the court exercising its discretion to relieve Pivotal of its obligation to post security for costs: Shuter v. Toronto Dominion Bank; Single Source Contracting Services Inc. v. Valiant Machine & Tool Inc., 2012 ONSC 6121.

[28] The counterclaim seeks damages for breach of the duty of good faith, breach of fiduciary duty, breach of the duties of confidence and non-interference with Pivotal’s economic interests and its contractual obligations. It is alleged that as a result of these breaches, Pivotal has not been able to meet its financial commitments, resulting in its shares no longer being traded and its business plan being indefinitely placed on hold. Specifically, Pivotal seeks a set off of $20,666,000 in damages arising from the alleged breach by Crossover of its obligation to invest the entire $5 million as agreed pursuant to the terms of the Equity Agreement and then its failure to raise an additional $20 million in funding from its US network of doctors.

[29] It was conceded Pivotal knew by June 25, 2012 that the Equity Agreement would be paid in tranches as opposed to a single lump sum payment, and that by October 4, 2013 it was known there would be no further payments made at all. Pivotal was represented by counsel at that time. The counterclaim was issued on November 30, 2016, more than two years after both alleged breaches.

[30] Pivotal also alleges Crossover interfered with their business operations and undermined their commercial negotiations. These events occurred during the period of April 2014 to October 2014. This involved efforts to oust the management team, the issuance by Crossover of an early warning report to alert the public with respect to concerns regarding its investment in Pivotal, and interference with potential partnership negotiations. Pivotal admits it was aware of all the facts underlying these allegations by early November 2014, more than two years before the counterclaim was issued.

[31] In respect of both the breach of the Equity Agreement and the interference with business operations allegations, it appears that Crossover may have a viable defence under the provisions of the Limitations Act, 2002, S.O. 2002, c. 24, Sched. B that these claims are statute barred.

[32] Pivotal alleges the complex corporate structure of Crossover enabled it to conceal its wrongdoings and misrepresentations, such that Pivotal only discovered its cause of action after the commencement of these proceedings. As a result, Pivotal submits the limitation period commenced with the issuance of the statement of claim. Further, Pivotal claims it was not legally appropriate to assert a claim in respect of these issues prior to the counterclaim as Crossover’s issuance of the statement of claim was a turning point which confirmed the irrevocable breakdown in the relationship.

[33] In this regard, Pivotal relies on a line of cases which held a claim may not be legally appropriate if there are alternative mechanisms for dispute resolution which have not been exhausted, or where the issuance of legal proceedings would affect the legal relationship between the parties: Linett v. Linett, 2012 ONSC 6894; Independent Plaza 1 Associates, LLC v. Figlionlini, 2017 ONCA 44; U-Pak Disposals (1989) Ltd. v. Durham (Regional Municipality), 2014 ONSC 1103; YESCO Franchising LLC v. 2261116 Ontario Inc., 2017 ONSC 4273; Apotex v. Nordion, 2017 ONSC 1323. Whether it was appropriate to commence legal proceedings will be assessed on the facts of each case.

[34] The cases relied upon by Pivotal can be distinguished. In each of the cases cited, there were statutory processes or legal relationships which directly impacted the ability of a party to commence action. As a result, the limitation period was effectively tolled until such time as the alternative remedial process was exhausted or the legal relationship was effectively terminated. In the circumstances, it was not legally appropriate to commence proceedings.

[35] The tactical choice to delay the commencement of legal proceedings in pursuit of settlement discussions after a loss, injury or damages is known does not make the proceeding legally inappropriate to warrant a tolling of the limitation period.

[36] Pivotal was not legally or statutorily precluded from commencing any action against Crossover in respect of the alleged breaches of contract, fiduciary duty or interference with economic interests and contractual obligations. Rather, it was a business decision taken with the hope there would be further financing made available from Crossover or its business associates. It was a tactical decision made for justifiable business reasons. The issuance of a claim against Crossover would most certainly have undermined the prospects for any additional funding. That however does not make the claims legally inappropriate.

[37] The complex corporate structure which purportedly allowed Crossover to conceal its alleged misrepresentations and wrongdoing could have been discovered at any point in time during which Pivotal engaged in business dealings with Crossover. The information was available through corporate and regulatory registrations. Pivotal’s evidence is that it undertook an investigation into the corporate structure of Crossover after the commencement of these proceedings and only then did it come to understand the interrelationships between the various Crossover entities and individuals. The claims that Crossover concealed its misrepresentations and wrongdoing by use of its complex corporate structure during the period of 2012 to 2014 may too be statute barred.

[38] The claims that Crossover interfered with the business affairs of Pivotal in 2015 by thwarting negotiations with potential investors would not be subject to a Limitations Act, 2002 defence as the claims are asserted within two years of the alleged wrongful conduct.

[39] The standard of proof on a motion for security for costs is not as required in a summary judgment motion. It may be, based on the full evidentiary record, Pivotal is able to adequately and appropriately respond to the allegation that its counterclaim is largely statute barred. For the purposes of this motion, as Pivotal is not impecunious, in order to resist a security for costs order Pivotal’s counterclaim must have a real possibility of success. Based on the evidence before me and the Limitations Act, 2002 defences to most of the claims asserted, I am not persuaded that significant aspects of the counterclaim do have a real possibility of success.

[40] Having concluded a security for costs order may be appropriate in respect of the counterclaim, I must consider whether it is just to make such an order, having regard to all the circumstances. As noted by the Court of Appeal in Yaiguaje v. Chevron Corporation, 2017 ONCA 827, the court must be vigilant to ensure a security for costs order is not used as a litigation tactic to prevent a meritorious claim from being heard. The factors to be considered in determining what may be just in the circumstances are the merits of the claim, any delay in bringing the motion, the impact of actionable conduct by the defendant on the available assets of the plaintiff, access to justice concerns, and the public importance of the litigation. These factors are non-exhaustive and are not to be considered as static or rigid in nature. Ultimately, it is the overriding interests of justice which must prevail in determining whether it is just for the court to exercise its discretion to make an order for security for costs.

[41] The relationship history between the parties would suggest there is an imbalance of power. It may be that the plaintiff has brought this motion with a heavy hand, however it has not been done to prevent a meritorious claim from being heard. To the contrary, it would appear that much of the counterclaim will not withstand scrutiny by the court. The plaintiff has not delayed in bringing this motion. The action is a commercial dispute between two corporate entities. It is not a matter with pressing public importance nor is it a matter where access to justice is a prevailing concern.

[42] Having considered the principles underlying the rule for security for costs, having applied the test enunciated in Rule 56 and the cases that have interpreted the Rule, and having examined the factors as to what is just in all the circumstances, I have concluded that it is appropriate to order security for costs in respect of the counterclaim.

[43] Crossover seeks $177,995.23 in security for the counterclaim. I view this amount to be excessive and disproportionate having regard to counterclaim and the scope of the litigation as a whole.

[44] Pivotal shall post security for costs in respect of the counterclaim on the following basis:

• $20,000 to be paid forthwith in respect of the costs incurred to date and through to the completion of examinations for discovery;
• $15,000 to be paid following completion of the examinations for discovery in respect of the costs from that stage of the litigation through to the completion of a pretrial conference;
• $45,000 to be paid following the pretrial in respect of the costs for preparation and attendance at trial.

[45] As both parties have been successful on their respective motions, there shall be no order as to costs.

Master J. E. Mills Date: October 9, 2018