Noranco Inc. v. Camilleri et al., 2019 ONSC 1173

Court File and Parties

COURT FILE NO.: CV-17-11770-00CL DATE: 20190219 ONTARIO SUPERIOR COURT OF JUSTICE (Commercial List)

BETWEEN:

NORANCO INC. Plaintiff/Respondent

– and –

DAVID CAMILLERI, KELLY CLINTON, MICHAEL BAUGHAN, ROBERT STEVENS MILLER, RAY VALEIKA and BDO CANADA LLP Defendants/Moving Parties

– and –

MIDOCEAN PARTNERS III, L.P., MIDOCEAN PARTNERS III-A, L.P., MIDOCEAN PARTNERS III-D, L.P., MIDOCEAN PARTNERS III-E, L.P., GALVAUDE PRIVATE INVESTMENTS INC., ANTARES HOLDINGS LP, Defendant

– and –

BDO Canada LLP Defendant

COUNSEL: Jason W.J. Woycheshyn and John Rawlins, lawyers for Noranco Inc. James Renihan, lawyer for David Camilleri Benjamin Bathgate, Stephen Brown-Okruhlik and Nicole Rozario, lawyers for Kelly Clinton. Wendy Berman, lawyer for Michael Baughan, Robert Stevens Miller, and Ray Valeika Jeff Galway, lawyer for MidOcean Partners III, L.P., MidOcean Partners III-A, L.P., MidOcean Partners III-D, L.P., MidOcean Partners III-E, L.P. and Galvaude Private Investments Inc. Sandy Lockhart, lawyer for BDO Canada LLP

HEARD at Toronto: January 8, 2019

F.L. Myers J.:

REASONS FOR DECISION

OVERVIEW

1The defendants (other than BDO Canada LLP) were all indirect shareholders of Noranco Inc. (“Old Noranco”). In 2015 they sold their shares to a corporate purchaser. The purchaser was later amalgamated with Old Noranco. So the current plaintiff is the successor to both the old operating business and the corporation that purchased it. The corporate structure of Old Noranco is more complex than is indicated by these sentences. However, the details are not germane to the outcome and are ignored for simplicity in these reasons.

2On April 18, 2017, the plaintiff sued the sellers - the institutional and individual shareholders of Old Noranco. The plaintiff claims that it paid too much for the business due to misrepresentations in the financial statements on which it relied in making the purchase.

3The individual defendants owned shares and were also directors or officers of Old Noranco. The moving party David Camilleri was the President and CEO of Old Noranco. Kelly Clinton was the Chief Financial Officer of Old Noranco. Michael Baughan, Robert Miller, and Ray Valeika were members of the board of directors of Old Noranco.

4The plaintiff claims damages in the amount of US$60,000,000 against the shareholder defendants who sold their shares to the plaintiff. Additionally, it claims against the individual defendant Clinton, personally, in the amount of US$60,000,000 for alleged breaches of his fiduciary duty and/or deceit for failing to properly investigate accounting practices at one of Old Noranco’s U.S. divisions which led to the misstatement of financial results on which the plaintiff bases its claim.

5The plaintiff also claims damages in the amount of US$60,000,000 against BDO Canada LLP which served as auditor of Old Noranco. In turn, BDO has brought a crossclaim against the individual defendants, as directors and officers of the audited corporation, seeking contribution and indemnity for any amounts which BDO is adjudged liable to pay to the plaintiff.

6The individual defendants seek orders requiring the plaintiff, as successor to Old Noranco, to make advances to them for the legal expenses that they have and will incur in defending this action. They rely on indemnification rights contained in: Old Noranco’s corporate by-laws, the share purchase agreement between Old Noranco and the purchaser, a unanimous shareholder agreement that was put in place among the shareholders of Old Noranco, bilateral agreements between individual defendants and Old Noranco, and sections 253 and 136 of the Ontario Business Corporations Act, R.S.O. 1990, c. B.16 (the “OBCA”).

7The plaintiff resists the motion, arguing that the moving parties have not met the conditions required for advancement of their legal expenses.

8For the reasons that follow, I find that the moving parties are entitled to advances from the plaintiff for their reasonable legal fees and disbursements incurred defending this action. Whether the defendant Clinton is entitled to full indemnification or must repay the amounts to be advanced, will be an issue for the trial.

9Additionally, on Monday February 4, 2019, a teleconference was held at the request of counsel for the plaintiff. He asked to make additional submissions on a question raised by me during the hearing of the motion. Counsel for Clinton objected, arguing that the plaintiff properly raised the issue in its factum already. I permitted counsel to file a two-page letter of additional submissions, giving parties opposite the opportunity to respond. In my view, given that: I raised the question in greater detail than had been addressed by the parties themselves; the plaintiff only sought to make brief submissions on a question of law; and no new facts were being submitted, in all the circumstances, it was in the interests of justice to receive the submissions as requested.

BACKGROUND

The Share Purchase Agreement

10By share purchase agreement dated July 26, 2015 (the “SPA”) the shareholder defendants agreed to sell all of the issued and outstanding shares of Old Noranco to the purchaser corporation. The purchaser agreed to pay an aggregate price of US$560 million subject to adjustments.

11A number of financial statements were attached as exhibits to the SPA including audited and unaudited consolidated financial statements of the company. Under s. 2.5 of the SPA, Old Noranco represented and warranted to the purchaser that the financial statements were prepared in conformity with International Financial Reporting Standards and that they presented fairly, in all material respects, the financial position of the company. Subection 7.1(a) of the SPA specified that the representations and warranties survived for a period of 18 months after closing. Subsection 7.1(b) of the SPA obligated the sellers to indemnify the purchaser for any inaccuracy of the representations and warranties.

Accounting Irregularities at Deer Valley

12On October 6, 2015 - two months after the SPA was signed and 24 days before closing - Camilleri advised the purchaser of irregularities in the financial reporting concerning Deer Valley, a US division of Old Noranco. Camilleri advised that Deer Valley had overstated its inventory which had resulted in its reported earnings to be overstated. The overstatement in inventory was due to intentional, improper inventory accounting practices that were being carried out by the division’s general manager and controller.

13The purchaser expressed concern that as a result of the misstatements of the results of the Deer Valley division in the financial statements, the purchase price in the SPA had been inflated by a significant amount.

14On October 30, 2015, the share sale closed with the purchaser reserving all rights and remedies regarding Deer Valley’s accounting irregularities.

NORANCO’S CLAIMS AGAINST THE MOVING DEFENDANTS

15In its statement of claim the plaintiff – the amalgamated Old Noranco and purchaser corporations - claims that as a result of the fraud in Deer Valley’s financial reporting, Old Noranco’s earnings were overstated by approximately US$2.6 million for fiscal 2014 and US$900,000 for 2015. It claims that Deer Valley’s inflated figures directly impacted the EBITDA of Old Noranco which the purchaser had relied upon in calculating and agreeing to the purchase price in the SPA. The plaintiff claims that had it known about the accounting issues before signing the SPA, it would not have agreed to the purchase price.

The plaintiff limits its claims to the purchaser’s entitlement against the former shareholders under the SPA (other than for the defendant Clinton)

16The plaintiff makes clear in its statement of claim that, apart from individual defendant Clinton, the claims advanced against the remaining shareholder defendants, both corporate and individual, are advanced against them solely in their capacities as shareholders and sellers under the SPA. The plaintiff pleads that it does not advance any claims against the individual defendants concerning their respective roles as directors or officers of Old Noranco (other than as against Clinton).

17The plaintiff claims that the sellers breached their contractual obligations under the SPA because the financial statements attached to the SPA did not, in all material respects, fairly reflect the financial position of the company. It claims that pursuant to s. 7.1(b) of the SPA, the sellers are required to indemnify the plaintiff, as the purchaser, severally and based on their respective ownership interests from, the purchaser’s losses relating to any inaccuracy in or breach of any representations and warranties. The plaintiff also claims against the shareholder defendants for unjust enrichment and for breach of the duty of good faith concerning the same financial misrepresentations.

18The plaintiff alleges that the sellers’ breaches of the SPA caused it financial harm because, as successor to the purchaser, it overpaid for the shares of Old Noranco. The plaintiff claims it is entitled to the difference between the purchase price paid under the SPA and the purchase price that would have been paid had the existence of the inventory fraud at the Deer Valley division been disclosed to it. The plaintiff pleads that it overpaid the sellers, at a minimum, an aggregate amount of approximately US$11.5 million.

The plaintiff’s claim against Clinton qua officer

19Unlike the other defendants, the plaintiff claims that Clinton, in his role as CFO of Old Noranco, breached his fiduciary duty owed to the company by concealing, failing to properly investigate, or failing to advise Old Noranco of the accounting irregularities at Deer Valley. At this stage, the plaintiff does not allege that at the time of the signing of the SPA Clinton knew of the actual fraudulent scheme being perpetrated by the officers of the Deer Valley Division. But it pleads that by then, he knew about significant red flags concerning inventory irregularities in Deer Valley. The plaintiff pleads that had he fulfilled his duties, Clinton ought to have discovered the fraud or at least the misstatement of results so as to prevent the misstatement in the financial statements attached to the SPA.

20The plaintiff alleges that Clinton’s breach of his fiduciary duties caused Old Noranco to improperly overstate its revenues and breach the representations and warranties in the SPA regarding the accuracy of the financial statements. Therefore, the plaintiff claims that it is entitled to recover from Clinton the damages suffered as a result of his breach of his fiduciary duties to his employer. (I note that this claim melds Clinton’s duties to Old Noranco with the losses allegedly suffered by the purchaser. Whether this affects the outcome is discussed below.)

THE INDEMNIFICATION PROVISIONS

21The individual defendants bring this motion to claim that the plaintiff, as successor to Old Noranco, has an obligation to indemnify them to the same extent that Old Noranco was required prior to closing as provided for in: the company’s by-laws; its unanimous shareholder agreement, bilateral agreements, and the OBCA.

22Additionally, the individual defendants claim that the SPA requires the purchaser to cause Old Noranco to indemnify them for a further six years following the closing of the SPA transaction to the same extent that they were entitled to an indemnity from it immediately prior to closing.

23The moving defendants, therefore, have claims for indemnity for legal expenses against both of the constituent corporations that make up the current amalgamated plaintiff entity.

24The relevant indemnification provisions are as follows:

The Company’s By-Laws

25The relevant provision of Old Noranco’s general by-law provides that:

6.2 Indemnity

1. Subject to the Act and to Section 6.2(2), the Corporation shall: (a) indemnify any individual who is or was a Director or officer of the Corporation and any individual who acts or acted at the Corporation's request as a director or officer (or any individual acting in a similar capacity) of another entity, against all costs, charges and expenses, including, without limitation, an amount paid to settle an action or satisfy a judgment, reasonably incurred by any such individual in respect of any civil, criminal, administrative, investigative or other proceeding in which such individual is involved because of his/her association with the Corporation or such other entity; and (b) advance money to a Director, officer or other individual for the costs, charges, and expenses of a proceeding referred to in [ ... ] (a). [ ... ].
2. The Corporation shall not indemnify an individual under Section 6.2(1) unless such individual: (a) acted honestly and in good faith with a view to the best interests of the Corporation or, as the case may be, to the best interests of the other entity for which such individual acted as a director or officer (or in a similar capacity) at the Corporation's request;
3. The Corporation shall also indemnify any individuals referred to in Section 6.2(1)(a) in such other circumstances as the Act or law permits or requires.

The Unanimous Shareholder Agreement

26The unanimous shareholders agreement for Old Noranco provided that the corporation “shall indemnify its officers against expenses, liabilities, and judgments in respect of actions, suits or proceedings to the fullest extent permitted by Ontario law”. The indemnity was limited to claims relating to the defendants in their capacities as directors or officers. Pursuant to the SPA, this agreement was terminated after the closing of the SPA.

Bilateral Indemnity Agreements

27The individual defendants were parties to their own indemnity agreements with the Old Noranco. The agreements provided each of the directors and officers with comprehensive indemnification for, among other things, damages, costs, expenses and legal fees reasonably incurred in respect of any civil action in which they are sued in their respective capacities as directors or officers. These agreements were terminated on the closing of the SPA transaction.

The SPA

28The purchaser assumed the indemnity obligations of Old Noranco pursuant to the terms of the SPA. In particular, s. 5.22 of the SPA states:

5.22 Director and Officer Liabilities. (a) D&O Liabilities. The Purchaser shall cause each Acquired Company to indemnify, from and after the Closing Date until the sixth anniversary of the Closing Date, each Person who was a director or officer of that Acquired Company immediately prior to the Closing to the extent that such Person was entitled to indemnification immediately prior to Closing, either pursuant to applicable Law or the Acquired Company's organizational documents, provided that no Acquired Company shall be required, and the Purchaser shall not be required to cause any Acquired Company, to indemnify any such Person with respect to any claims made against such Person by a Seller or by any member of the board of directors, manager, board of managers, or any other supervisory board of the Acquired Companies.

The OBCA

29The relevant sections of the OBCA are as follows:

Indemnification 136 (1) A corporation may indemnify a director or officer of the corporation, a former director or officer of the corporation or another individual who acts or acted at the corporation’s request as a director or officer, or an individual acting in a similar capacity, of another entity, against all costs, charges and expenses, including an amount paid to settle an action or satisfy a judgment, reasonably incurred by the individual in respect of any civil, criminal, administrative, investigative or other proceeding in which the individual is involved because of that association with the corporation or other entity. (2) A corporation may advance money…

BDO CANADA LLP CLAIM AND CROSSCLAIM

30In this litigation, the plaintiff also claims against BDO for auditor’s negligence and negligent misrepresentation concerning the Deer Valley inventory misstatement in Old Noranco’s financial statements.

31In response, BDO advanced a crossclaim seeking contribution and indemnity from the senior management and directors of Old Noranco who, BDO allege:

• undertook to ensure fair presentation of financial statements;
• were responsible, at all material times, for the accuracy of the company’s financial statements; and
• knew, or ought to have known, about the alleged fraud, and either deliberately or recklessly misled BDO as auditor.

POSITIONS OF THE PARTIES ON THE MOTION

32In Blair v. Consolidated Enfield Corp., [1995] 4 S.C.R. 5 the Supreme Court of Canada listed three conditions for a director or officer to satisfy to become entitled to receive indemnification for his or her legal fees under the OBCA:

(a) The director or officer is a party to the litigation by reason of being a director or an officer of the corporation; (b) The costs must have been reasonably incurred; and (c) The director or officer must have acted honestly and in good faith with a view to promoting the best interests of the corporation.

33The plaintiff argues that the individual defendants, other than Clinton, have not satisfied the first two conditions. The plaintiff says it sued them as shareholders under the SPA and not for anything done by them as officers or directors of Old Noranco.

34The plaintiff concedes that while Clinton is sued for conduct in his capacity as an officer of Old Noranco, it submits that Clinton cannot satisfy the third criterion because his breaches of duty amounted to bad faith. The plaintiff confirms that it does not take the position on this motion that any of the other shareholder defendants are disentitled to indemnification on the basis that they acted in bad faith.

The Claim against individual defendants qua shareholder

35The individual defendant Camilleri argues that the court should approve the advance of monies to him on account of legal expenses under s. 6.2(1)(a) of the general by-law as made applicable to the purchaser and therefore to the plaintiff under the SPA. Camilleri argues that although he is sued under the SPA as a shareholder, he is involved in the proceeding because of his “association with” Old Noranco. He argues he has been sued because of his association with Old Noranco and that this is sufficient to trigger his entitlement to an indemnity under the particular wording of the by-law. The wording “association with” used in the by-law is wider than the wording used in the other indemnities and Blair that limit the obligation to indemnify more strictly to acts taken in the capacity as director or officer. Even as a shareholder, Camilleri argues, he is sued for acts done in “association with” Old Noranco.

36The defendants Baughan, Miller, and Valeika similarly argue that the court should require payment of their legal expenses on the same basis because of their “association with” Old Noranco. They were members of its board of directors with oversight responsibility for the financial reporting of the company.

37All of the moving defendants add that even if the plaintiff’s claims do not implicate their positions as directors or officers, BDO’s crossclaim relates entirely to their conduct in their indemnified, fiduciary roles with the Old Noranco.

38The plaintiff argues that its claims against the individual defendants in this action are brought against them exclusively as shareholders. The claims flow directly from the breach of the SPA. It adds that BDO’s crossclaim against the defendants is not a new cause of action but instead is a derivative of the plaintiff’s main claims advanced against the defendants and therefore it creates no additional rights in the defendants.

The Claim against Clinton

39The plaintiff claims that Clinton breached his fiduciary duties owed to Old Noranco by recklessly ignoring the mounting accounting irregularities at Deer Valley for months, if not years, before the SPA was signed. The plaintiff alleges that, in so doing, Clinton acted in bad faith and contrary to the interests of Old Noranco, and therefore he is disentitled to indemnification under the by-laws and other indemnification provisions.

40Clinton maintains that as CFO of Old Noranco, his employer owes him, at minimum, advanced payments of his legal costs to defend the claims of both the purchaser (who is now the plaintiff) and BDO. Clinton argues that the plaintiff has failed to satisfy its burden of establishing a strong prima facie case that he acted in bad faith as required by Blair. Clinton argues that the plaintiff has led no affidavit evidence on the motion supporting its position and instead relies upon its “alleged facts” set out in its statement of claim.

41Clinton also argues that the cause of action that he is facing is really that of the purchaser rather than of Old Noranco. Clinton argues that even if he breached a duty to Old Noranco, he did not harm Old Noranco as the company whose shares were being sold. Clinton argues that any breach of his duties to his employer gave the purchaser no rights against him.

Existence of a funding agreement

42The plaintiff asserts that the individual defendants have not and will never incur legal fees in defending this action because they are parties to funding agreements with the institutional shareholder defendants MidOcean and Galvaude. Therefore, the plaintiff submits that no expenses have been or will be reasonably incurred by the individual defendants and there are therefore no fee obligations for it to indemnify.

ISSUES

43The overarching issue on this motion is whether the moving defendants’ rights to payment of legal expenses in advance of obtaining judgment apply in this action. The following points will be addressed:

1. Is being sued as a shareholder an “association” sufficient to trigger indemnification rights under the Old Noranco’s general by-law?
2. If not, is there any other basis upon which the moving defendants are entitled to advances on account of their legal expenses?
3. Is the evidence sufficient to establish a strong prima facie case of bad faith conduct by Clinton so as to disentitle him to funding?
4. Does the existence of third party funding preclude the individual defendants from recovering under their indemnity rights?
5. Has the process adopted by the plaintiff denied Clinton a fair opportunity to make his case?
6. Does the plaintiff have a good cause of action against Clinton or has it improperly blended a claim by the purchaser for the purchase price under the SPA with a claim for breaches of duty that Clinton owed to Old Noranco?

ANALYSIS

Issue 1: Is a shareholder “association” sufficient to trigger advancement of legal expenses?

44Old Noranco’s by-law provided indemnity to directors and officers who are sued in proceedings “in which such individual is involved because of his/her association with the Corporation”. All of the other sources of indemnity and advancement rights relied upon by the moving defendants more carefully limit their entitlement to claims brought against them in their capacities as officers or directors of Old Noranco. The moving defendants assert that the word meaning in the by-law must be given effect with the result that even claims brought against them as shareholders under the APS are subject to indemnity and advancement.

45I do not agree. The purpose of indemnifying directors and officers is to protect and encourage people to serve as fiduciaries on behalf of others. In Blair, the Supreme Court of Canada considered the policy goals underlying corporate indemnification: “Indemnification is geared to encourage responsible behavior yet still permit enough leeway to attract strong candidates to directorship and consequently foster entrepreneurship” (Blair, at para. 74; See also: Bennett v. Bennett Environmental Inc. (2009), 2009 ONCA 198, 94 O.R. (3d) 481 (C.A.), at paras. 23, 25).

46Indemnification of potential directors and officers is so important that the topic is dealt with in the statute, the corporation’s by-laws, the shareholders’ unanimous shareholder agreement, and then further still, in individuals’ bilateral agreements with Old Noranco. The shareholders of Old Noranco insisted that their indemnity rights be carried into the SPA and the purchaser agreed. These are important rights that should not be lightly interfered with and whose scope should be as certain as possible.

47As pointed out by the plaintiff, the interpretation proposed on behalf of Mr. Camilleri would entitle him to be indemnified for his costs if the company sued him for failing to repay a shareholders’ loan. Mr. Camilleri’s counsel responded that the exception for acts contrary to the best interests of the company could then be relied upon by the company to refuse the indemnity. But that is an argument that just reaches for words without considering the intent and import of the provision. A shareholder has no general obligation to act in the best interests of the corporation. There is no policy reason to delve into a parsing of whether a shareholder who is adverse to the corporation in litigation may nevertheless be acting in the best interests of the corporation. Moreover, there is no policy basis to extend the scope of the indemnity to shareholders absent a bilateral agreement to that end.

48It is not clear why the wording of the by-law omits the limiting wordings found in each of the other operative indemnification documents in this case. It appears that the author amended standard forms to insert a gender neutral “his/her.” There is no indication of any negotiation of a different scope of indemnity or that the by-laws intended to change the scope of what each of the other documents provides. I find that the words “association with” take their meaning from their context. The opening words of subsection 6.2(1)(a) of the by-law expressly limits indemnity rights to directors and officers of the corporation. That is the “association” referred to in the closing sentence of that subsection. I also find that the interpretation of “association with” in this by-law should be consistent with the other relevant indemnification provisions including the SPA, the bilateral indemnities in place, and the OBCA which are all restricted to indemnifying claims in association with peoples’ capacities as directors or officers. This interpretation is consistent with the policy goals underlying indemnification.

49Therefore, I do not accept, on this basis alone, that the use of the wording “association with” in the by-law can be so broadly interpreted so also capture the moving defendants’ capacities as shareholders.

Issue 2: Is there any other basis upon which the moving defendants are entitled to advancement of their legal expenses?

50While the plaintiff argues that its claim is limited solely to attacking the moving defendants (other than Clinton) in their capacities as shareholders alone, in my view, as drafted, the claims are far broader than that. The plaintiff, as the successor of the purchaser, claims for breach of contract, breach of a duty of good faith, and unjust enrichment - all of which are predicated on allegations of improper and fraudulent accounting practices, failing to investigate the irregularities at Deer Valley, and making inaccurate representations in the financial statements. These claims implicate directly the conduct of the individual defendants in their fiduciary capacities.

51This finding is supported by Noranco’s statement of claim, at paras. 51(h) and (i), which state:

(h) Camilleri and Clinton knew as of (at the least) January 15, or were willfully blind to the fact, that the inventory reported by Deer Valley was overstated. Both Camilleri and Clinton also understood that understated inventory would have the effect of improperly overstating profits. (i) Despite the knowledge and understanding by Camilleri and Clinton, the issues with Deer Valley reporting were not properly investigated or corrected. The Senior Management Sellers who knew of or were willfully blind to these accounting issues and overstated profits at Deer Valley also failed to disclose these accounting issues or the fraudulent and wilful nature of these accounting issues to the Purchaser in the lead up to executing the SPA. [Emphasis added.]

52The factual matrix underlying the plaintiff’s claims involves and explores the individual defendants’ duties, knowledge, and actions. The claim of unjust enrichment against all of the shareholder defendants will inevitably consider the justness of each receiving the purchase price as a result of their knowledge and actions. The knowledge that they had and the things that they did or did not do, make it impossible to distinguish between their roles in responding to plaintiff’s allegations. For example, the plaintiff claims that the board members ought to be liable qua selling shareholders for failing to advise of the problems with the financial statements on a timely basis. But, if Clinton or Camilleri reported problems at Deer Valley to the board of directors, that information came to them with their fiduciary duties attached. The question of whether they would have, should have, or could have disclosed the information to the purchaser under the APS will necessarily involve a consideration of what they were entitled to do as fiduciaries – as officers and directors - owing, at the same time, duties to Old Noranco to act in its best interest.

53Moreover, the individual defendants’ are completely implicated in their fiduciary capacities in the crossclaim by BDO. Had Old Noranco sued BDO in a separate action and BDO had added the individual defendants by way of a third party claim, there is no doubt that Old Noranco would be required to indemnify its officers and directors (absent bad faith). The fact that Old Noranco and the purchaser have amalgamated and purport to sue BDO and the individual defendants together makes it much harder to separate the capacities of the defendants even if the plaintiff sues the individual defendants only qua shareholder (which I have rejected above). In any event, the factual narrative for trial – the story of how the fraud at Deer Valley arose and was not discovered until mid-2015 - is identical in both the plaintiff’s claims and the BDO crossclaim.

54I add that I disagree with the plaintiff’s submission that the BDO crossclaim is somehow derived from or limited by the plaintiff’s claims against the shareholder defendants. BDO’s right to claim-over is derived from the claim against it, the common law, and the Negligence Act, R.S.O. 1990, c. N.1 and not from the plaintiff’s claims against the other defendants. As mentioned above, if BDO alone were sued, it could add the individual defendants as third parties. Given the clear wording of BDO’s crossclaim, which is aimed at the senior management and the directors of the Old Noranco, I find that the moving defendants are entitled to payment of their legal costs in relation to the BDO crossclaim and that the facts relating to the individual defendants’ involvement in the cross-claim are not practically or legally distinguishable from the facts underlying the plaintiff’s claims against them.

Issue 3: Is the evidence sufficient to establish a strong prima facie case of bad faith conduct by Clinton?

55As set out in Blair, in order for the plaintiff to deny payment to an officer who otherwise qualifies, the plaintiff must establish a strong prima facie case that Clinton acted mala fides towards the Old Noranco (Cytrynbaum v. Look Communications, 2013 ONCA 455, at para. 27). Mala fides or bad faith includes fraud or misappropriation against the corporation. It may also include conduct coloured by opportunistic or self-seeking behaviour which exhibits a type of dishonesty that should not be countenanced by an award of indemnity: Bennett at para. 29. It can also encompass recklessness, described as conduct that is so inexplicable it leads to the inference of an absence of good faith: Entreprises Sibeca inc. c. Frelighsburg (Municipalité), 2004 SCC 61, at para. 25; Cytrynbaum, 2013 ONCA 455, at para. 90.

56The strong prima facie test is a stringent one that gives significant protections to officers and directors. It is not sufficient for the plaintiff to simply raise an allegation of bad faith in the pleadings or to make bald, unsubstantiated allegations to that effect. Counsel all agreed that a strong prima facie case is one that is very likely or nearly certain to succeed at trial. The high burden ensures that directors and officers will ordinarily receive advance funding, but still leaves open the possibility that payment of funds can be denied when there is strong evidence of wrongdoing. This result follows from the need to maintain a balance between, on the one hand, encouraging responsible behaviour by directors and officers and, on the other hand, permitting enough leeway to attract strong candidates to foster entrepreneurism (Bennett, at para. 3; Cytrynbaum, 2013 ONCA 455, at para. 42).

57The plaintiff relies on mounting “red flags” of inventory fraud beginning in 2013, culminating with the close of the share purchase transaction in October 2015. The plaintiff alleges that the “red flags” are evidence of Clinton’s:

• knowledge of the improper inventory practices at Deer Valley;
• failure to investigate despite repeated concerns raised by senior management at the company; and
• failure to disclose that the financial statements contained overstated earnings – which were passed on to the purchaser and incorporated into the SPA.

58Moreover, the plaintiff submits that Clinton’s misconduct was motivated by and designed to further his personal financial interest in maximizing the purchase price under the SPA.

59The basis of the plaintiff’s bad faith allegations against Clinton stem from the alleged facts set out in its statement of claim, the transcript of the examination of Alyson Slapkauskas, the former Director of Operations of Old Noranco, the evidence of Camilleri and Clinton, as well as the plaintiff’s lead witness, Cindy Fullmer, the Director of Finance of the purchaser.

60The plaintiff argues that Clinton’s knowledge of and failure to respond to a myriad of accounting irregularities are established by e-mails among him, senior management at Old Noranco, and management at Deer Valley. This includes, for example, e-mails from Camilleri openly questioning the capitalization of inventory costs, the legitimacy of reported inventory values, and Clinton’s continued reliance on management at Deer Valley after they had been expressly reprimanded for improperly manipulating inventory reporting. Additionally, the plaintiff points to e-mails where Clinton instructs staff to release reports to Old Noranco senior management that are known to contain inaccurate figures.

61Clinton, however, takes issue with the evidence relied on by the plaintiff, arguing that it fails to properly contextualize the narrative. Clinton argues that the plaintiff selectively references several e-mails and seeks to draw adverse inferences on what those e-mails meant based on an incomplete evidentiary record. Many were older and involved discrete incidents that could not possibly have had anything to do with a future share sale that was not yet on the horizon.

62Counsel for Clinton points to the decision of Cytrynbaum v. Look Communications, 2012 ONSC 4578 where, in response to an indemnification application, the company opposing indemnification delivered an eight volume record of approximately 4,000 pages containing affidavits from seven different affiants, including an expert in executive compensation, provided supplementary affidavits, and cross-examined five witnesses (Cytrynbaum, 2012 ONSC 4578 at paras. 47, 51).

63Here, while the evidence establishes that Clinton appreciated there were irregularities at Deer Valley, I find that this is insufficient by itself to support an inference that he knew of, was reckless, or willfully blinded himself to the improper inventory practices being carried out by management at that plant. Clinton maintains that he had no direct knowledge of the improper practices being carried out at Deer Valley until its discovery in September 2015 following which he immediately made arrangements to attend Deer Valley to investigate. He also submits that during the relevant time period, there were several operation-specific factors, unrelated to improper conduct, that caused spikes in inventory levels at Deer Valley. He maintains that this obscured his understanding that the inventory figures were inaccurate from an accounting perspective and the result of fraudulent actions by local management. Clinton submits that he carried out his duties to review any inventory concerns as they were discovered, explaining that he delegated appropriately to employees, consultants, and professional advisors who were most closely involved in Deer Valley’s operations and who were in the best position to confirm the information being provided.

64While I am entitled to engage in some limited weighing of the evidence at hand, in my view, I do not have a sufficient understanding of the full story to properly assess Clinton’s conduct. The plaintiff’s evidentiary record leaves me guessing at motive and trying to piece together a number of discrete events to find a basis to draw an overall inference. But without a better understanding of the individual incidents and the linkages – or lack of linkages – between one and the next, I cannot at this time, on this evidence, infer conduct reaching the level of opportunistic or self-serving behaviour that exhibits a type of dishonesty that would likely or very likely result in a finding of bad faith. (Cytrynbaum, 2012 ONSC 4578 at para 88, 90).

65There is no doubt that Clinton knew there were inventory problems at Deer Valley. The evidentiary record clearly shows that he was informed of and responded to issues being raised. The plaintiff hangs its mala fides argument on the basis that Clinton did not appropriately or effectively respond to the problems so as to detect the underlying inventory fraud at Deer Valley. It argues, in essence, that Clinton left the Deer Valley division in the hands of the foxes whom he had reason to know were raiding the henhouse. Clinton maintains that, as CFO, he responded based on the information provided to him and his less fulsome understanding of the situation at the Deer Valley. While Clinton’s actions or inaction raises questions as to why he did not do more, I find that this points more toward negligence than to bad faith at this stage. As such, I do not find that the plaintiff meets the evidentiary threshold required to support a strong prima facie case of bad faith on this motion. It remains open to it to try to do so at the trial or other disposition of the action.

Issue 4: Does the existence of a funding agreement preclude the individual defendants from recovering?

66Within a few months of the plaintiff commencing the action, the individual defendants entered into legal fee funding agreements with the corporate shareholder defendants MidOcean and Galvaude. The terms of the agreements have not been disclosed due to privilege.

67The plaintiff takes the position that the individual defendants should not be entitled to advances of funds for legal expenses because their costs are being funded pursuant to a funding agreement. It argues that the individual defendants have not incurred, and will not incur any legal expenses with respect to this action.

68I do not agree. The existence of a funding agreement and the individual defendants’ ability to pay for their legal costs through other means is irrelevant in a motion seeking to enforce corporate indemnity rights (Med-Chem Health Care Ltd. v. Misir, 2010 ONCA 380, at para. 27). None of the by-law, the SPA, the OBCA, or the other sources of indemnity rights and obligations requires a moving party to establish that he or she has no ability to pay as a basis for seeking indemnity.

Issue 5: Has there been procedural unfairness to Clinton?

69Clinton claims that prior to his cross-examination, the plaintiff’s only discernible allegations against him were those set out in its statement of claim. He submits that he learned about the substance of the bad faith allegations for the first time when the plaintiff’s lawyers put documents and emails to him on cross-examination. He complains that the plaintiff’s counsel refused to advise, in advance of Clinton’s cross-examination, what documents would be put to him. Instead, Clinton argues that the plaintiff waited to put certain documents him at cross-examination from which it tried to make its case on this motion.

70The plaintiff properly disclosed its relevant documents in advance, it chose not to introduce them into evidence in an affidavit that set out a story told by witness with personal knowledge. Rather, the plaintiff’s counsel first put the documents to Clinton on cross-examination. Clinton’s counsel says that Clinton was not able to either prepare for the use made of the documents or to respond fully during or after cross-examination. I do not accept the procedural argument. Clinton and his counsel had months to prepare on the documents. If counsel believed that the cross-examination left an incomplete story, he had the opportunity to ask questions on re-examination or to move for leave to file further evidence. It was open to counsel for Clinton to address pleadings concerns by a demand for particulars pursuant to r. 25.10 under the Rules of Civil Procedure, R.R.O. 1990, Reg. 194. Similarly, pursuant to r. 39.03, it was also open to the parties to summons further witnesses.

71Having said that, I do recognize that this is not a motion for summary judgment. The plaintiff has presented a very summary view of the facts through a number of disembodied emails. Neither side was obliged to put its “best foot forward” in the sense of advancing all of the evidence on which it will rely at trial.

72Given the myriad of tools available to the parties to address process concerns, I reject the assertion that Clinton suffered any unfairness as a result of learning about the substance of the allegations at his cross-examination. The plaintiff was entitled to try to prove its case in cross-examination. This is not an unfair process. But, in the end, it was one that in this case lacked proof of a sufficiently detailed and cohesive narrative to enable the court to draw the inference that the plaintiff sought.

Issue 6: Does the plaintiff have a good cause of action against Clinton or has it improperly blended a claim by the purchaser for the purchase price under the SPA with a claim for breaches of duty that were owing to Old Noranco?

73Clinton submits that the plaintiff’s theory of his liability is flawed. He argues that the personal claim against him purports to be a claim by his former employer, but is in substance one for damages suffered by the purchaser for the alleged diminution in the value of the target company in the SPA rather than any losses suffered by Old Noranco. Clinton submits that he was not an employee of the purchaser and he did not owe it any fiduciary or other duties.

74Additionally, pointing to paras. 80-81 of the Statement of Claim, Clinton maintains that the only allegation against him is that he breached his duties owed to Old Noranco. This cannot make him liable to re-pay a piece of the purchase price to the purchaser. The happenstance of the amalgamation of the purchaser and Old Noranco has led the plaintiff to merge Old Noranco’s claim against Clinton with the purchaser’s claim for damages under the SPA.

75The plaintiff alleges that it does not need to prove damages to hold Clinton liable for breach of fiduciary duty to Old Noranco. This was the issue on which the parties delivered further submissions after the motion was taken under reserve.

76In light of my holding that the plaintiff has not proven bad faith to the requisite standard, I do not need to resolve this issue. Clinton will receive advances of his legal expenses regardless of whether the plaintiff has a good cause of action against him or not. This issue can be taken up at trial if necessary.

ORDER

77The moving defendants are entitled to an order requiring the plaintiff to pay them, in advance of judgment, the amount required to pay the reasonable costs, charges, and expenses that they incur to defend this action including the crossclaim of BDO regardless of any funding agreements that the moving defendants may have with anyone else.

78Nothing in this order limits the plaintiff’s entitlement to claim reimbursement of the funds that it pays under the preceding paragraph to the defendant Clinton at the trial of this action if it is able to prove its allegations of bad faith.

79The parties agreed that as between the plaintiff and the defendants Camilleri, Baughan, Miller, and Valeika costs of the motion on a partial indemnity basis in the amount of $12,000 all-inclusive would be paid to the successful parties. The plaintiff will therefore pay Camilleri costs of $12,000 and the defendants Baughan, Miller, and Valeika a further aggregate sum of $12,000 forthwith.

80The plaintiff incurred costs on a partial indemnity basis of approximately $112,000 for which it attributes 80% to dealing with its claims against Clinton. For his part, Clinton argued that he incurred costs of $235,000 to deal with the motion. Counsel for Clinton submitted that he had to review a large amount of documentation to try to glean the story against his client in view of the plaintiff’s failure to identify for him the documents on which it intended to cross-examine his client. In my view, counsel has conflated the costs properly attributable to the motion with the costs of document discovery in the action proper. Counsel has to review documentary discovery in the action regardless of any motion practice. Moreover, I know of no rule that holds a party liable in costs for declining to advise the party opposite of the details of a proposed cross-examination in advance. There was no trial by surprise or ambush. All of the documents were properly disclosed. How counsel chose to deal with the claimed lack of particulars and the needs to learn the case were matters between him and his client.

81The fixing of costs is a discretionary decision under section 131 of the Courts of Justice Act, R.S.O. 1990, c. C.43. That discretion is generally to be exercised in accordance with the factors listed in Rule 57.01 of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194. These include the principle of indemnity for the successful party (57.01(1)(0.a)), the expectations of the unsuccessful party (57.01(1)(0.b)), the amount claimed and recovered (57.01(1)(a)), and the complexity of the issues (57.01(1)(c)). Overall, the court is required to consider what is “fair and reasonable” in fixing costs, and is to do so with a view to balancing compensation of the successful party with the goal of fostering access to justice: Boucher v. Public Accountants Council (Ontario) (2004), 71 O.R. (3d) 291 (C.A.), at paras 26, 37.

82In my view, the costs claimed by Clinton are excessive. It is only due to the plaintiff’s claim of nearly $90,000 that I consider a number nearer to that than to the amounts agreed with the others. Mr. Camilleri’s cross-examination ran through much of the same events and emails as the cross-examination of Mr. Clinton. Nevertheless, it is clear that the issue of bad faith occupied the lion’s share of the controversy. Accordingly, in my view, the plaintiff should be required to pay costs to Clinton of $90,000 on a partial indemnity basis all-inclusive. That would equate to 60% of full costs of approximately $150,000. Nothing in this order precludes Clinton from seeking costs at trial for document discovery that is not duplicative of the costs attributable to this motion ($150,000) for which partial indemnity recovery ($90,000) is already granted.

83Finally, in my view, I should not lose sight of the fact that the real economic issues at play are between the purchaser and the corporate, institutional shareholders MidOcean and Galvaude. The issue on this motion, reduced to its practical essence, was whether the plaintiff had to cover the costs of the individual defendants or the corporate defendants had to do so. There is no doubt that the plaintiff’s real target in the lawsuit is the corporate shareholders who received the vast bulk of the purchase price. I suspect that the plaintiff will find it particularly galling to have to fund costs of those whom it believes it overpaid for their shares due to their own wrongdoing which benefited the corporate shareholder defendants in the main. But the plaintiff has named individuals in its lawsuit for its own tactical reasons (presumably to ease its path to get at the corporate defendants) and the plaintiff has to accept the consequences of doing so.

84Nevertheless, the court should not be blinded to the economic realities at play. The ultimate benefit of this order enures to the corporate shareholder defendants. Therefore, in the event that the plaintiff succeeds at trial in having Clinton ordered to reimburse the plaintiff for sums advanced on account of legal expenses as ordered herein, in my view, it is a fair exercise of my discretion to award costs under s. 131 of the Courts of Justice Act, R.S.O. 1990, c. C.43 and Rule 57.01 and to attach terms to relief ordered under Rule 1.05, that the corporate shareholder defendants MidOcean and Galvaude each be jointly and severally liable to the plaintiff for any obligation on Clinton to repay the sums advanced to him on account of legal expenses. If Clinton cannot repay legal costs that the plaintiff advanced and proves it is entitled to have reimbursed, this term is required to prevent the corporate shareholder defendants from being unjustly enriched at the plaintiff’s expense.

F.L. Myers, J.