COURT FILE NO.: CV-14-10635-00CL
DATE: 20190514
ONTARIO
SUPERIOR COURT OF JUSTICE (COMMERCIAL LIST)
BETWEEN:
EXTREME VENTURE PARTNERS FUND I LP, EVP GP INC., RAVINDER KUMAR SHARMA, IMRAN BASHIR, and KENNETH TESLIA
Plaintiffs/Defendants by Counterclaim
– and –
AMAR VARMA, SUNDEEP MADRA, VARMA HOLDCO INC., MADRA HOLDCO INC., CHAMATH PALIHAPITIYA, EL INVESTCO 1 INC., EXTREME VENTURE PARTNERS ANNEX FUND I LP, EVP GP ANNEX FUND I INC., CASSELS BROCK & BLACKWELL LLP, and SEVEN HILLS GROUP LLC
Defendants/Plaintiffs by Counterclaim
Won J. Kim, Megan B. McPhee and Aris Gyamfi, for the Plaintiffs/Defendants by Counterclaim
Ira Nishisato, Katherine J. Menear and Katie Archibald, for the Defendants/Plaintiffs by Counterclaim, Amar Varma, Sundeep Madra, Varma Holdco Inc., Madra Holdco Inc., Extreme Venture Partners Annex Fund I LP and EVP GP Annex Fund I Inc.
David E. Lederman, Daniel Cappe and Larissa Fulop, for the Defendants Chamath Palihapitiya and El Investco 1 Inc.
HEARD: January 21-25 and 28-30; February 4-8, 19-22, 25-26, and 28; March 25-28; April 2, 9, 12 and 23, 2019
reasons for judgment
Conway J.
INTRODUCTION
[1] Extreme Venture Partners Fund I LP (“Fund I”) is a venture capital fund that provides seed capital to start-up technology companies. It was established in November 2007 by (i) the plaintiffs Ravinder Sharma (“Ray”), Imran Bashir (“Imran”) and Ken Teslia (“Ken”); and (ii) the defendants Amar Varma (“Amar”) and Sundeep Madra (“Sunny”).
[2] In December 2011, Amar and Sunny established a second fund named Extreme Venture Partners Annex Fund I LP (the “Annex Fund”). They obtained $5 million in financing from Northleaf Capital Partners (“Northleaf”), the investment manager for the Ontario Venture Capital Fund. The Annex Fund invested in six of Fund I’s most successful portfolio companies and operated for two years until it closed down in December 2013.
[3] The plaintiffs claim that Amar and Sunny surreptitiously established and operated the Annex Fund in breach of their fiduciary and contractual duties (the “Annex Fund Claim”). The plaintiffs claim that Amar and Sunny’s conduct tarnished the Extreme Venture Partners brand and damaged their reputation and investment opportunities.
[4] The plaintiffs have a second claim. One of Fund I’s investments was a mobile software development lab business co-founded by Amar and Sunny, Xtreme Labs Inc. (“Xtreme Labs”). Fund I and the individual plaintiffs held shares in Xtreme Labs, as did Amar and Sunny, personally or through their holding companies or family trusts. Amar and Sunny were the co-chief executive officers of the company.
[5] In August 2012, the plaintiffs sold their shares in Xtreme Labs to the defendant Chamath Palihapitiya (“Chamath”), through his personal holding company El Investco 1 Inc. (“El Investco”). Chamath is a prominent Silicon Valley entrepreneur, a founding senior executive at Facebook, and a good friend of Amar and Sunny. The purchase price was based on an enterprise value for Xtreme Labs of USD$18 million. The selling shareholders received USD$12 million for their shares of Xtreme Labs. Amar, Sunny and the Xtreme Labs employees received USD$6 million in ongoing equity of the company.
[6] In October 2013, Chamath negotiated the sale of shares of Xtreme Labs to Go Pivotal, Inc. (“Pivotal”) for USD$60 million. Prior to the sale, Chamath, Amar and Sunny carved certain assets out of Xtreme Labs and transferred them to a holding company of which they were the sole shareholders.
[7] One of those assets was a 13% equity interest in Hatch Labs Inc. (“Hatch Labs”), which had developed the mobile dating app Tinder (“Tinder”). In March 2014, the holding company sold its interest in Hatch Labs to InterActive Corp (“IAC”) for USD$30 million.
[8] The plaintiffs allege that Amar and Sunny misrepresented the financial status of Xtreme Labs and concealed material information from them, including the equity interest in Hatch Labs and the existence of Tinder. The plaintiffs further allege that Amar, Sunny and Chamath conspired with one another to cause the plaintiffs to sell their shares of Xtreme Labs at a discounted price and realized the true value of the company for themselves in the following 18 months (the “Xtreme Labs Claim”).
[9] The defendants deny these allegations. They say that the plaintiffs have rewritten history and that this is simply a case of sellers’ remorse.
[10] For the reasons that follow, I find for the plaintiffs. In the Annex Fund Claim, I conclude that Amar and Sunny breached their fiduciary duties as managing directors of Fund I and that their holding companies breached their obligations under the shareholders agreement for the general partner.
[11] In the Xtreme Labs Claim, I conclude that Amar and Sunny breached their fiduciary obligations and conspired with Chamath to acquire the company at a discounted price. They further concealed the existence of the equity interest in Hatch Labs and Tinder and appropriated the value of that asset for themselves.
[12] This is not a case of tough business tactics and clever negotiating strategy. Nor is it a case of sellers’ remorse. This is a case of a purchaser conspiring with fiduciaries of a company to acquire a business and doing so based on breaches of fiduciary and contractual duties.
FACTUAL OVERVIEW
[13] The events in question occurred over a seven year period from 2007 to 2014. Many of the critical events in the Annex Fund Claim took place in 2011 and overlap with those in the Xtreme Labs Claim. This factual overview sets out the events with respect to both claims, largely in chronological order. In order to understand the basis for my factual findings, I must set out the facts, which are complex, in some detail.
[14] The key players and witnesses in the Annex Fund Claim are as follows:
Name
Party/Non-Party
Witness at Trial
Fund I, EVP GP, Ray, Imran, Ken
Plaintiffs
Ray, Imran, Ken
Amar, Sunny, Varma Holdco, Madra Holdco
Defendants
Amar, Sunny
Annex Fund, EVP GP Annex Fund I Inc.
Defendants
No
Northleaf, investment arm of Ontario Venture Capital Fund (Melissa McJannet, managing director of Northleaf)
Non-Party
No
Locationary (Grant Ritchie, founder and CEO)
Non-Party
Yes
Stephan May, Robert Ferguson
Plaintiffs’ Experts
Yes
Andrew Cochran
Defendants’ Expert
Yes
[15] The key players and witnesses in the Xtreme Labs Claim are as follows:
Name
Party/Non-Party
Witness at Trial
Fund I, EVP GP, Ray, Imran, Ken
Plaintiffs
Ray, Imran, Ken
2006 Teslia Family Trust
Non-Party (Ken’s family trust)
No
Amar, Sunny, Varma Holdco, Madra Holdco
Defendants
Amar, Sunny
Chamath, El Investco
Defendants
Chamath
Hello Warrior
Non-Party (Chamath’s family trust)
No
Henry Quan
Non-Party (director of Xtreme Labs)
Yes
Farhan Thawar
Non-Party (VP Engineering of Xtreme Labs)
No
Mansoor Ahmed
Non-Party (bookkeeper for Xtreme Labs)
Yes
Hatch Labs
Non-Party (13% of equity owned by Xtreme Labs)
No
Dinesh Moorjani
Non-Party (CEO of Hatch Labs)
Yes
Pivotal (Rob Mee, CEO)
Non-Party (U.S. fee for service company that acquired Xtreme Labs in 2013)
No
IAC (Barry Diller, Chairman)
Non-Party (owned 87% of equity of Hatch Labs)
No
2390184 Ontario Inc. (owned 50% by El Investco and 25% by each of Amar and Sunny)
Non-Party (incorporated to acquire shares of Hatch Labs on carve-out of sale to Pivotal)
No
Stephan May, Robert Ferguson
Plaintiffs’ Experts
Yes
Andrew Cochran
Defendants’ Expert
Yes
Establishment and Organization of Fund I and Xtreme Labs
Establishment of Fund I and Xtreme Labs
[16] Ray is a venture capitalist specializing in the mobile application sector of the tech industry. In 2007, he met Amar and Sunny. They decided to establish a venture capital fund that would finance Amar and Sunny’s software lab business as well as other early stage technology companies. The software lab was intended to be Fund I’s core investment and the lens through which to evaluate other Fund I investments.
[17] Ray enlisted the help of Ken, his friend and an experienced venture capitalist, and Imran, a technology entrepreneur, to finance these entities.
[18] In November 2007, Fund I was registered as a limited partnership and its general partner, EVP GP Inc. (“EVP GP”), was incorporated. The shares of EVP GP were owned by Ray, Imran and Ken (22.22% each), and Amar and Sunny’s personal holding companies Varma Holdco Inc. (“Varma Holdco”) and Madra Holdco Inc. (“Madra Holdco”) (16.67% each).
[19] Also in November 2007, Xtreme Labs was incorporated to operate the software lab business. According to Amar, the day before the parties were scheduled to sign the documents for Fund I, Ken demanded that he, Ray, and Imran be given a direct equity interest in Xtreme Labs. Amar’s evidence is that he and Sunny were not happy about Ken’s 11th hour demand but they felt they had no choice but to give in, as they wanted to do something bigger with Fund I and needed the arrangement with the plaintiffs. He testified that while this threat did not set them off on the best foot with their new partners, they were optimistic that the business would succeed and they focused on building it. The original equity of Xtreme Labs (less 5% for Pivotal) was split equally among Ray, Imran, Ken, Varma Holdco and Madra Holdco.
Management of Fund I and Xtreme Labs
[20] EVP GP managed the business of Fund I. The board of directors of EVP GP consisted of Ray, Imran, Ken, Amar and Sunny, who also sat on Fund I’s Investment Committee. Amar and Sunny were the managing directors of EVP GP. They were responsible for all aspects of the day to day operations of Fund I and recommended to which portfolio companies Fund I should invest in.
[21] Xtreme Labs had a similar management structure. The board of Xtreme Labs consisted of Ray, Imran, Ken, Amar and Sunny (and later Henry Quan, a consultant to Xtreme Labs). Amar and Sunny were the managing directors and co-CEOs of Xtreme Labs and were responsible for all of its day-to-day operations.
[22] Amar and Sunny were compensated for their work on Fund I and Xtreme Labs through the equity interest in EVP GP and a salary and bonus from Xtreme Labs.
Funds Raised for Fund I
[23] Fund I raised approximately $5.9 million in investment funds pursuant to an Offering Memorandum dated May 20, 2008. The minimum subscription was USD$50,000. Ray and Ken brought in 29 of the 31 limited partners of Fund I, consisting of various high net worth individuals and luminaries of Bay Street, Toronto.
[24] Amar brought in the remaining two investors, one of whom was Chamath. Amar and Chamath met in the mid-1990s when they were students together at the University of Waterloo. They became good friends and Amar was the best man at Chamath’s wedding. Shortly after graduating from university, Chamath moved to Silicon Valley but he and Amar continued to remain close friends.
[25] Amar and Sunny had known one another since early 2000. Sunny had gone to the University of Ottawa and moved to Silicon Valley shortly after graduating. In the mid-2000s, Amar introduced Chamath to Sunny.
[26] Chamath invested in Fund I through his family trust Hello Warrior LLC (“Hello Warrior”). Chamath testified that he wanted to help Amar and Sunny by allowing them to leverage his name with other investors but wanted to minimize the capital that he invested. Ray agreed to loan $50,000 to Hello Warrior to acquire its limited partnership unit. In September 2010, Hello Warrior also acquired a small shareholding in Xtreme Labs.
[27] Each of Ray, Imran, Ken, Amar and Sunny, personally or through their holding companies or family trusts, acquired limited partnership units in Fund I.
Fund I Invests in Xtreme Labs
[28] Fund I acquired its initial investment in Xtreme Labs in December 2007. Fund I invested USD$300,000 for a 47.5% equity stake in Xtreme Labs. In 2010, it made an additional investment in Xtreme Labs in a second round of financing.
Governing Agreements
[29] The agreements governing the operation of Fund I and Xtreme Labs are:
• the Extreme Venture Partners Fund I LP Amended and Restated Limited Partnership Agreement dated May 20, 2008 (the “Fund I LP Agreement”);
• the EVP GP Shareholders’ Agreement made as of June 20, 2008 (the “EVP GP Shareholders’ Agreement”); and
• the Xtreme Labs Shareholders’ Agreement dated May 21, 2010 (the “XL Shareholders’ Agreement”).
Organization Chart
[30] The following is an organization chart for Fund I and Xtreme Labs as they were established, organized and capitalized in 2007 and 2008:
Early Years of Fund I and Xtreme Labs
[31] In addition to its investment in Xtreme Labs, Fund I also invested in other technology start-up companies, including Chango, Locationary, Local Response, Vouchr Ltd. and well.ca Inc. It had some successful exits of its portfolio companies, including BumpTop, which was sold to Google in 2010 for $35 million. Amar and Sunny, as the managing directors, were responsible for tracking Fund I’s investments and interacting with the portfolio companies.
[32] Xtreme Labs also grew rapidly in the initial years. The company’s clients included The Globe and Mail, Thomson Reuters, Cineplex, Bell and CIBC.
[33] Xtreme Labs’ annual revenues increased substantially, from $1.5 million in fiscal year (“FY”) ended September 30, 2009, to over $4 million in FY 2010, and over $10 million in FY 2011.
Tensions between the Parties Start in 2010
[34] By late 2010, tensions started to develop in the relationship between Ray, Imran and Ken, on the one hand, and Amar and Sunny, on the other. Amar and Sunny testified that they were doing all the work to grow the Fund I and Xtreme Labs businesses and were not being properly recognized or compensated for their work. They were not happy with their equity in Xtreme Labs. They felt that Ray, Imran and Ken were disengaged, focused on other business activities, not supporting them in closing deals with clients, and passively waiting for a return on their investments. However, despite these tensions, the relationship continued and Amar and Sunny remained in their roles as managing directors and co-CEOs.
Fund 2 and the Annex Fund
[35] From the outset, the partners of Fund I had discussed the concept of establishing a second fund (that they referred to as Fund 2). According to Ray, when Fund I was established, he envisioned it as the first of a series of funds under the Extreme Venture Partners brand. The parties discussed the idea of a Fund 2 and explored the idea of attracting institutional capital for this second fund.
[36] Amar and Sunny testified that it was always understood that they were free to build on their experience with Fund I and operate a second fund themselves. They testified that they had accepted the lopsided economics of Fund I because they knew they would be able to create a second fund on their own, without the plaintiffs’ involvement.
[37] In 2009, the Ontario Venture Capital Fund and the Ontario Emerging Technologies Fund announced that there were public funds available for start-up companies in the technology sector. In 2009 and 2010, Amar sent limited partnership updates to the partners of Fund I asking for assistance on how to best position Fund I to leverage these programs. Ray assisted Amar in his efforts to secure this funding through Northleaf and provided feedback to Amar on a presentation deck to Northleaf in May 2010.
Sunny Meets with Ms. McJannet and the Annex Fund Concept Develops
[38] In November 2010, Sunny was on a plane to California. He was sitting beside Melissa McJannet, managing director of Northleaf, who was reading a Toronto Life magazine article profiling the “tech genius millionaires who are turning Toronto into the new Silicon Valley”. The article included a photograph of Amar and Sunny. Ms. McJannet and Sunny began talking about establishing a fund together, with Northleaf as the primary limited partner.
[39] Amar met with Ms. McJannet in December 2010 and discussed the concept of the Annex Fund, which would invest in the Fund I portfolio companies. Amar testified that Ms. McJannet suggested the “Extreme Venture Partners Annex Fund” name as a placeholder, which ultimately stuck. Amar and Sunny did not tell Ray, Imran or Ken about the meeting with Ms. McJannet.
[40] In April 2011, Northleaf confirmed to Amar and Sunny that it was prepared to move forward with funding of $5 million for the Annex Fund.[^1] Ms. McJannet sent Amar and Sunny a due diligence checklist requesting information about themselves, Fund I and its portfolio companies.
[41] On May 18, 2011, an off-site directors’ meeting was held for Fund I and Xtreme Labs (the “May 2011 Off-Site”). Amar and Sunny made a presentation about a prospective Fund 2. The deck for the meeting has several slides about raising $30 million in funding for “EVP Fund 2”; building a model using the current fund and removing co-investors; approaching large institutions; and bringing in a recognized partner. Amar’s evidence is that he told the plaintiffs that the “recognized partner” was a reference to Northleaf. Ray testified that Amar and Sunny did not say anything about Northleaf to the plaintiffs at the meeting.
[42] Amar and Sunny responded to Northleaf’s due diligence request a week later. They did not copy Ray, Imran or Ken on their response. Amar and Sunny stated in their response that they had established EVP as THE brand for entrepreneurs to get involved, that they would be the sole owners in the fund and that there was no anticipated ownership of the fund for the founding partners of Fund I.
[43] The due diligence document included a list of Fund I board seats and observer positions and descriptions of internal Fund I decision making processes, including due diligence, investment decision making and portfolio company monitoring. Over the ensuing months, Amar and Sunny gave Northleaf additional information including the Fund I NAV table of investments (including names of investee companies, co-investors, investment date and cost, realized value, carrying value and ownership percentage), current and future capital requirements of Fund I portfolio companies, follow-on investment projections for Fund I portfolio companies, and a copy of the Fund I limited partnership agreement.
The Annex Fund is Established
[44] On December 19, 2011, the Annex Fund was established. Northleaf committed $5 million to the Annex Fund and received 99% of the limited partnership units. Amar and Sunny each invested $25,000 for 0.5% of the units. Varma Holdco and Madra Holdco owned all of the shares of the general partner, EVP GP Annex Fund I Inc. (“Annex GP”). The Annex Fund invested in six of Fund I’s most successful portfolio companies. Amar described these as the “winners of the portfolio” to Ms. McJannet.
[45] After the Annex Fund was established, Amar and Sunny continued to provide Northleaf with information about Fund I’s portfolio and investment strategy. In September 2012, Amar sent Ms. McJannet Fund I’s detailed NAV Table as well as information about investee company revenue and founders, investment type and other detailed information about Fund I investments.
Sale of Xtreme Labs
[46] By 2011, the parties had started to explore options to sell Xtreme Labs. At the May 2011 Off-Site, the board discussed an exit strategy. The directors also talked about bringing on new board members to take the business to the next level – Amar and Sunny suggested Chamath as a possible board replacement. The slide deck contains several slides about Pivotal, another fee for service technology company in the U.S., stating that Pivotal was on a path to grow to $100 million in three years and that Xtreme Labs had the unique opportunity to work directly with Pivotal to grow the business.
November 2011 Board Meeting and 2012 Business Plan
[47] By the time of the Xtreme Labs board meeting in November 2011, Amar and Sunny presented the 2012 business plan, which painted a very different picture from the prior years’ rapid growth. Management’s revenue forecast for FY 2012/13/14 was $12/$14/$16 million, with expected 15% year over year growth. The $12 million projected revenues for FY 2012 were only 18.6% over the company’s actual revenues for 2011, compared with actual revenue growth of well in excess of 100% in previous years ($1.5 million in FY 2009, to over $4 million in FY 2010, to over $10 million in FY 2011).
[48] The business plan set out the 2012 goals and objectives for the company. It listed numerous challenges facing the company, such as strong competition in the fee for service market space; difficulties in employee retention and hiring; and the need for proprietary offering opportunities. Amar testified at length about the various headwinds facing the company at the time. He stated that the business plan was one that accurately reflected the state of the company and the revenue forecasts that management thought it could meet.
[49] Ray, Imran and Ken were surprised and disappointed with the negative projections, given the historical growth trajectory of the company. However, they testified that they did not have any data to contradict it, as they relied on the data provided by management.
[50] The discussions of exiting the business continued after the November 2011 board meeting. Ray suggested to Amar and Sunny that they consider pursuing a management buyout that would enable them to retain their interests in the company, replace the board and take the company in the direction they thought best.
Initial Efforts to Sell Xtreme Labs
[51] There was a difference in opinion among board members about what Xtreme Labs was worth. Imran proposed an independent valuation of the company. Amar resisted the idea as he thought it would set an artificial ceiling on what a purchaser would pay for the company.
[52] Amar and Sunny thought the value of the company was at the low end of a $5 to $20 million range. Henry Quan thought it was worth in the $15 to 20 million range. Imran thought the best case was $20 million. Ray thought the company had much higher value, in the $40 million range. He said he would take the lead to solicit offers from interested buyers.
[53] Ray testified that he asked Amar and Sunny repeatedly to help prepare pitch decks for prospective purchasers. He never received a slide deck until after Chamath offered to buy the company a few months later. Around that time, there had been a soft offer by Facebook to purchase the company for $5 million[^2] but the board never seriously considered it. Ray made some efforts to sell the company in late 2011 and early 2012, none of which materialized.
Revenue Forecasts to Samsung and ThinkEquity Presentations
[54] In November 2011, around the same time as the board meeting, Sunny made a presentation to JK Shin, head of the mobile business unit at Samsung, at a conference in Seoul, South Korea. Sunny’s presentation to Samsung projected Xtreme Labs’ 2012 revenues to be $20 million. Chamath had invited Sunny to the conference and attended the presentation. Sunny did not tell Ray, Imran and Ken about this presentation to Samsung.
[55] In January 2012, Ray, along with Amar and Sunny, delivered a marketing presentation to the investment bank ThinkEquity, which also included a projection of $20 million in revenues for 2012.
[56] According to Sunny, the reason he used the $20 million forecast in his presentations instead of the $12 million forecast given to the board was that these were marketing pitches designed to highlight the company’s capabilities to a potential customer or buyer. He did not want to publicly discuss the risks facing the business at the time.
Chamath Offers to Buy the Company
[57] On February 1, 2012, Chamath sent an email to Sunny asking him to come and see him that day because he wanted “to talk about buying extreme labs.” Chamath testified that he wanted to buy Xtreme Labs for strategic, not financial, reasons. His evidence is that he saw the world migrating to the mobile internet experience and wanted to acquire the pool of approximately 80 software engineers employed by Xtreme Labs. By that time, he had left Facebook and founded Social Capital LP, a Silicon Valley venture capital firm.
[58] Sunny worked near Chamath’s office in Silicon Valley. He met with Chamath that day. Both Chamath and Sunny testified that it was a very general meeting. Sunny and Amar testified that they did not recall saying anything to the board about this meeting as they did not think Chamath was serious about buying Xtreme Labs. Amar testified that he had not had any previous discussions with Chamath about buying Xtreme Labs and that he did not speak to Chamath about the February 1 email. Sunny said that he did not recall if he spoke to Amar after the meeting and that he did not have any further oral or face to face discussions with Chamath until March 20, 2012. Sunny testified that he and Chamath probably would have texted during that time but he did not have copies of his text messages as he had changed phones since then.
[59] On March 16, Sunny sent Chamath and Amar an email about the acquisition of Pivotal by EMC Corporation. Chamath responded:
your board should know that the acquisition value was about 1x current year revenues…Scott Yara is the sponsoring exec and is a good friend. He told me.
[60] Sunny responded to Chamath, copying Amar:
That is amazing for the hammer drop this week! Board mtg is set for wed! Key folks are on board.
[61] Sunny testified that his comments were intended to encourage Chamath to prepare a written offer for the company. He denied that a board meeting had been set for the following Wednesday.
[62] On March 20, Chamath, Amar and Sunny had dinner together in Toronto and went to Amar’s apartment afterwards. Chamath used Amar’s computer to prepare a draft offer to purchase Xtreme Labs. The offer assumed an implied enterprise value for the company of $12 million, with $8 million for the non-employee investors and $4 million in ongoing equity for the employees and principals (Amar and Sunny).
[63] The offer included a reference to “Comps”. It stated that Pivotal was purchased by EMC a few days before for $28 million, representing 0.75x current fiscal year projections and 1x calendar year 2011 revenues. It also referred to the $5 million Facebook offer in 2011.
[64] The offer contained a strongly worded threat under the heading Contingencies:
I am very excited to work with you and your team, Amar and Sunny, but at the same time am compelled to make sure that I am acting in my own financial best interests. If a speedy consummation of this acquisition looks untenable, I want to be completely honest that I will begin an active and aggressive recruiting program for all qualified engineers and senior executives within the greater Toronto area to build an Xtreme Labs competitor in Toronto. I will also use my relationships to advantage this new entity to the fullest extent possible including but not limited to a wide array of US based companies with which I have strong relationship. Further, I would like to make you both an offer to be Co-Founder and Co-CEOs, respectively, of this new entity with me and share in its upside in a meaningful way and materially better than that which you have currently.
[65] Chamath emailed the draft to Amar, who made some changes. Amar shortened the deadline for accepting the offer from March 28 to March 26 and added a provision that escrowed funds would only be released if the sellers did not breach their duty of confidentiality with respect to the transaction. Amar admits to making the changes but testified that he did so on Chamath’s instructions. Amar and Sunny made no change to the “Contingencies” clause. Amar testified that he asked Chamath to take it out. Sunny testified that he did not ask Chamath to take it out, as it only would have made him dig his heels in further. Amar emailed the revised draft back to Chamath.
[66] Chamath sent the revised offer to Amar and Sunny on the evening of March 20. Amar forwarded it to the rest of the board on the morning of March 21 with the note “Guys – this is the email we got last night from Chamath to buy out the company and move it fwd…” Immediately after Amar sent the offer, Amar and Sunny sent a slide deck to the board recommending that it accept Chamath’s offer. Amar and Sunny did not tell Ray, Imran or Ken that they had been with Chamath the previous evening, working on the offer.
[67] Ray was furious with Chamath’s threat. He emailed Chamath, accused him of blackmail and reminded him of the loan he had made to Chamath to invest in Fund I. He also raised concerns over whether Chamath had confidential information about the company and whether Amar and Sunny were conflicted.
[68] The board did not accept the offer. On March 24, the board (Ray voting against it) made a counter-offer. The terms included an implied enterprise value of $15 million; an extension of the deadline to March 29; a non-solicitation of Xtreme Labs employees for 12 months; and a carve-out of the shares of Xtreme Labs’ investments in two subsidiaries Glooko Inc. (“Glooko”) and Extreme Startups Inc. (“Extreme Startups”).[^3] Chamath responded and accepted the $15 million valuation but rejected the other terms of the counter-offer. He stated that he did not accept the carve-out because he was not willing to pay more for less. Amar and Sunny encouraged the board to accept Chamath’s offer at $15 million.
Activity from March 24 to 26
[69] At the same time as the offer and counter-offer were being exchanged, Amar and Sunny were having email discussions with Chamath about their compensation and equity. Chamath proposed salary and bonus figures that were between 60% and 260% higher than what Amar and Sunny were paid in 2011.
[70] In an email on March 24, Chamath requested information about the Xtreme Labs organization review, detailed HR review, attrition plan and strategic plan. On the HR review, Chamath asked for a” ranked list of everyone from 1 thru n. who are our top5? Top10? Split up by job type”. He told Amar that Farhan Thawar (the company’s VP of Engineering) should help them with this. Amar told Chamath he could give him that information and Sunny responded that he could walk through it with Chamath the next day. Chamath testified that he was only asking for this information in order to deflect the conversations about management compensation.
[71] In an email from Amar to Chamath on March 24 regarding management compensation, Amar stated that the revenue plan as of that day was “$15M/$20M/$30M: 2012/2013/2014 @ 20% operating margins.” Amar’s evidence is that these numbers were calendar year figures, assumed that Chamath would help management in closing a series of accounts, and were only included in the context of his compensation negotiations.
[72] From March 24 to March 26, Amar and Sunny sent numerous emails and arranged phone calls with the board members, trying to persuade them to accept Chamath’s deal. Amar told the plaintiffs that if they did not accept it, the plaintiffs would have to invest $5 million more to get the company to the next level and their interest would have to be diluted by 50% to allocate more equity to the employees.
[73] On March 24, Mr. Thawar sent an email to the Executive Team at the company, stating “In terms of partners, I can’t think of a better partner than CP for XL.” Sunny forwarded the email to Amar and Chamath. Ray, Imran and Ken testified that they had not advised Mr. Thawar that Chamath had made an offer for Xtreme Labs.
[74] At a meeting on March 26, the directors considered giving the board an M&A mandate to sell the company using an auction process. Under the XL Shareholders’ Agreement, this would have required the approval of 5 out of the 6 directors. Amar and Sunny voted against a board M&A mandate. The directors also considered authorizing Ray to solicit alternative bids and to set up a data vault for potential buyers to conduct due diligence. Amar said that if they could not get an extension on Chamath’s offer then there was no reason to give Ray an authorization to solicit bids or to set up a data vault.
Disagreement re Earnings Multiple
[75] On March 24, Ray called Rob Mee, CEO at Pivotal. Ray’s evidence is that he understood from his conversation with Mr. Mee that a 3x multiple of earnings would be a fair number to accept and relayed this information to the other directors.[^4] Amar disagreed and said that “Until we look at Rob’s bank account we don’t know. I can tell you if he got 3x sales I will name my first born after him. He most likely got 1x and anything else if it exists was an earn out. That is in line with what we are seeing in the market.” Amar also referred the board members to a 2010 Deloitte valuation of Xtreme Labs, in which the recommended multiple for the company was 0.6-0.7x sales.
[76] In mid-April, Sunny arranged a call between Mr. Mee and the board members. On April 13, in advance of the phone call, Sunny asked Mr. Mee to clarify what he told Ray and to say that “consulting businesses typical [sic] are valued at 1-1.5x revs.”
Seven Hills Valuation Conducted
[77] Despite Amar and Sunny’s efforts to persuade them to accept Chamath’s offer, Ray, Imran and Ken pushed back. On March 26, the board decided that it would obtain an independent valuation.
[78] Amar emailed Chamath about the board’s decision and said “we need some more time” and that it might take another month to obtain the valuation. He told Chamath that all of the directors were onside except for Ray. He stated “we know our best path fwd in this business is with you, and we are going to do everything we can to make that happen.” He told Chamath that “the company on its current course has a ton of momentum”, which would be hard to recreate if they set up another company with Chamath. Chamath was upset that it might take another month and told Amar that they might have a valuation but might not have an offer.
[79] The board decided to use a Silicon Valley investment bank, Seven Hills Group LLC (“Seven Hills”) to conduct a fairness valuation.[^5] Amar and Sunny as management were tasked with providing the required information to Seven Hills. Imran was appointed by the board to “own” the valuation process and was copied on and participated in most of the communications with Seven Hills; however, he testified that he trusted Amar and Sunny to deal directly with Seven Hills in his absence.
[80] Amar and Sunny provided a comprehensive package of information to Seven Hills, including financial statements, organizational material, information about contract opportunities in the pipeline, conversion rates, and customer lists. The revenue projections provided to Seven Hills were the ones presented to the board in the 2012 business plan, namely $12/14/16 million for FY 2012/13/14.[^6] Amar and Sunny’s evidence is that they still believed at that time that the revenue forecasts were accurate. Amar testified that he thought the $12 million was still reasonable because January and February had been the poorest months in the company’s history, and its utilization rate (percentage of staff used on billable projects) was at a historical low.
[81] Imran did not raise any concerns about the information provided to Seven Hills. Ray had a call with Seven Hills in which he gave his views on the business but did not raise any concerns with the financial information that Amar and Sunny had provided.
[82] On April 16, Seven Hills presented its valuation of Xtreme Labs to the board. Its report concluded that Xtreme Labs was worth between $11 to 14 million, relying on information provided by management. Ray, Imran, Ken, and Henry Quan had the opportunity to ask questions about the report. They testified that they did not agree with the valuation but did not have any data to contradict the information or assumptions it was based on.
Board makes April 29 Offer to Chamath
[83] Shortly after receiving the Seven Hills valuation, the board made a new offer to Chamath. The offer was based on an enterprise value of $18 million, with no carve-outs. In the offer, the selling shareholders would receive $12 million. The principals (Amar and Sunny) and employees would receive $6 million in ongoing equity. Imran testified that he came up with the number, which was calculated as a 1.5 multiple on $12 million revenue.[^7] Imran testified that the Seven Hills report was used as a data point in coming up with the proposed purchase price.
[84] On April 29, the board voted in favour of making the $18 million offer to Chamath. Amar and Sunny abstained from voting. Chamath accepted the board’s offer. That day, Amar and Sunny sent Chamath a letter of intent for the sale transaction that had been agreed to by the members of the board. Amar also sent Chamath a memorandum of understanding between Amar, Sunny and Chamath with details on how they would operate the business going forward. The memorandum of understanding stated that the projected revenues of Xtreme Labs were $15M/$20M/$30M for 2012/13/14.
[85] There was a delay in Chamath signing back the documents. On May 4, Amar emailed Chamath stating that they needed him to sign back and kickstart the legals quickly as “[t]he Sellers may get cold feet as more data comes in.” Amar testified that he was simply trying to put pressure on Chamath to sign back the documents. Chamath’s evidence is that he regarded this as a pressure tactic and disregarded it. He returned the signed documents on May 8.
Closing of Transaction
[86] After the letter of intent was signed, Chamath asked three of his friends in Silicon Valley to invest in the transaction with him. His evidence is that the $18 million was outside his comfort zone and he wanted to off-set some of his risk. He sent an email to Divesh Makan (the manager of his family office), Nicolas Berggruen and Dave Goldberg on June 7. In his email, he provided actual revenue and EBITDA figures for calendar year 2011 and estimated figures for calendar year 2012. He also stated (my emphasis added):
• Calendar year 2012 actual revenues: “the team has done $1.6M and $1.8M in revenues in April and May and are on a run rate to do $2-$2.5M per month thru the rest of next year. They are now confident that they will do somewhere between $20-25M in revenues.” Chamath testified that he obtained the $1.6 and $1.8 million numbers from Amar.
• Purchase price: Total consideration of $8M for 41.6% (total enterprise value ~$19 m or 1x current year revenues).
• Comps: Extreme Labs’ US counterpart, Pivotal Labs, was bought by EMC for $96M. Purchase price was 2.5x current year revenues.
[87] Mr. Makan and Mr. Goldberg invested in the Xtreme Labs transaction. In June 2012, Chamath also required Amar and Sunny to contribute $2 million towards the transaction.[^8]
[88] The parties signed a Redemption and Share Purchase Agreement on July 13, 2012. Attached to the agreement were the audited financial statements for FY 2011, unaudited statements for six months ending March 31, 2012 and cash balances up to May 31, 2012. The purchaser in the agreement was El Investco, which Chamath incorporated in July 2012 to acquire the Xtreme Labs shares. The selling shareholders included Fund I, Ray, Imran and Ken’s family trust. Amar and Sunny were identified as Founders of the company, not as part of the purchasing group.
[89] On July 17, Amar emailed Chamath with the revenue and profit numbers for each quarter of calendar year 2012. He stated that quarter 2 was a “RECORD QUARTER” and that momentum was building. He stated that they had hit the target run-rate of $2 million per month in June. He estimated July to be a “RECORD MONTH”, with revenues of $2 million, and August revenues at $1.5 million plus another $300,000. He stated that he was confident with the target of $16 million in revenue for calendar year 2012 and that if the momentum kept up, they could reach $18 million.
[90] In the Redemption and Share Purchase Agreement, Amar and Sunny warranted that there had been no material change in the business or material contracts entered into by the company since January 31, 2012. Ray, Imran and Ken’s family trust warranted that they had received all of the information necessary or appropriate in deciding to enter into the transaction and that they had an opportunity to ask questions and receive answers from Xtreme Labs and its management prior to closing.
[91] The transaction closed on August 15, 2012.
Events Post-Closing
[92] On September 5, shortly after closing, Chamath spoke at a Town Hall for the Xtreme Labs employees. In the video of this Town Hall played at trial, he talked about how the previous owners of the company were “douchebags”, “fuckfaces” and “idiots that were counterproductive.” He described how he had known Amar and Sunny for a long time and had come up to Toronto in 2007 to help them raise a seed fund and start Xtreme Labs. He described how at the 11th hour the ownership structure of the company got “convoluted” and in his opinion, Amar and Sunny “got taken advantage of”. He said that “over the course of this last year, sort of instigating and pushing and prodding, we finally found the path to basically buy Xtreme and recapitalize it.”
[93] On September 27, Chamath’s friend Phil Deutch sent him an email that included a headline “Chamath Palihapitiya Personally Buys Majority Stake in Mobile Development Shop Xtreme Labs”. The subject matter of the email was “yet another deal I get iced on!” Chamath responded “25% net cash margins, 100% YoY revenue growth – should do $35-40M next year. We bought it for $16M. Yum yum!!!!” Chamath’s evidence is that this was a big joke among friends and that the numbers were all made up.
[94] The actual revenues for Xtreme Labs for FY ended September 30, 2012 were $17.2 million, approximately 43% higher than the forecast provided to the board in November 2011 and to Seven Hills in April 2012.[^9]Amar’s evidence is that this $5.2 million discrepancy was due to four key projects from existing customers – Facebook, the NBA, the NFL and Thomson Reuters – that materialized some time after April 2012. He testified that:
• Facebook was a longtime customer, identified as a key customer in the 2012 business plan and to Seven Hills. The Facebook revenues increased by $3 million after April 2012 as a result of a project that materialized over a lunch with Sheryl Sandberg, who wanted the Facebook app on her Blackberry phone;
• the NBA was shown as a $150,000 opportunity in the company’s Sales Force Pipeline Printout given to Seven Hills. The NBA opportunity grew after April 2012 based on Chamath’s ownership in the Golden State Warriors;
• Thomson Reuters was identified as a potential customer in the 2012 business plan and the potential value of the work was $1 million, which was not confirmed at the time of the Seven Hills valuation. It materialized after April 2012 because Chamath was a guest blogger for Bloomberg; and
• the NFL was given a zero value on the Sales Force Pipeline Printout but this opportunity grew because of Chamath’s personal connections.
[95] The defendants testified about the “Chamath effect”. They said that after the letter of intent was signed and in the year after closing, Chamath leveraged his contacts to acquire more business for Xtreme Labs, changed the structure of the executive team and increased the number of engineers hired.[^10]
[96] In October 2013, Chamath negotiated the sale of Xtreme Labs to Pivotal for USD$60 million. Prior to closing, Xtreme Labs transferred the shares of Glooko, Extreme Startups and Hatch Labs to a holding company, 2390184 Ontario Inc. (“239 Ontario”), which was wholly owned by Chamath, Amar and Sunny or their holding companies.
[97] In March 2014, 239 Ontario sold its interest in Hatch Labs to IAC for USD$30 million.
Plaintiffs’ Discovery of the Annex Fund
[98] Amar and Sunny continued to serve as managing partners of Fund I following its exit from Xtreme Labs in August 2012. At the same time, Amar and Sunny continued to operate the Annex Fund.
[99] In 2012, Ray, Imran and Ken started to hear rumours that Amar and Sunny were running a new fund. On July 19, 2012, Ken emailed Amar about one of these rumours, saying “Very bad and if you care about reputation you should do it right.” Amar responded “we have been punting big institutions for years now.” Ken testified that he did not pursue it at the time because he trusted his partners.
[100] In 2013, the rumours continued. In April 2013, Ray asked Amar if he had set up a new fund. Amar said that he had “set up Suresh and Andy to run a new fund.” In August 2013, Ken sent a Financial Post article to Amar and Sunny entitled “Extreme Venture Partners rumoured to be bowing out of the fund business.” Amar responded “there is not a new fund closed as of today.”
[101] The plaintiffs’ evidence is that by this point, they had lost faith in Amar and Sunny and decided to sever their relationship and buy their interests in EVP GP. Ray, Imran and Ken exercised their rights under the buy-sell shotgun in the EVP GP Shareholders’ Agreement (the “Shotgun”). On November 4, 2013, the transaction closed and Ray, Imran and Ken purchased the shares of EVP GP held by Varma Holdco and Madra Holdco for $1,450,291.
[102] Ray’s evidence is that he did not discover until after the closing of the Shotgun transaction that the Annex Fund had been established on December 15, 2011 and had invested in six of Fund I’s portfolio companies. He testified that he emailed Fund I’s corporate financial advisor at CIBC after the Shotgun transaction closed, to advise him of the change in ownership and to freeze all activity in the EVP accounts. Ray’s advisor emailed him about an account for “EVP Annex Fund”. Ray testified that it was the first he had heard of an Annex entity.
[103] One of the portfolio companies was Locationary Inc. (“Locationary”). Grant Ritchie, the founder and CEO of Locationary, testified that Fund I had been an early investor in the company. In 2012, Locationary was doing another round of financing. Mr. Ritchie’s evidence is that all of the communications and documents referred to “EVP”, “Extreme Venture Partners” and “Extreme Venture Partners Fund I LP”. The financing closed in May 2012, with all of the documents in the name of Fund I.
[104] Five months later, Mr. Ritchie received a request from the Annex Fund’s counsel stating that the warrants and share certificates issued to Fund I on closing had to be reissued to the Annex Fund. Mr. Ritchie thought it had been a clerical error. He testified that he had no reason to believe that Fund I and the Annex Fund were unrelated because both used the “Extreme Venture Fund” or “EVP” name, and he interacted with the same individuals for both funds. It was not until June 2013 that he discovered that there was a difference between the two entities.
[105] In December 2013, Amar and Sunny’s relationship with Northleaf terminated. The assets of the Annex Fund were transferred to Northleaf and the partnership was dissolved in June 2014.
[106] Ray testified that in 2014, he tried to raise capital from Northleaf and other institutional investors for a second EVP fund but was unable to do so. However, he did raise two more EVP funds (“EVP Funds II and III”). EVP Fund II raised over $10 million and had nearly 100% participation of Fund I investors.
CREDIBILITY AND FACTUAL FINDINGS
[107] I found Amar, Sunny and Chamath not to be credible witnesses. I accept very little of their evidence on contested issues of fact. I found their testimony to be creative and contrived, and an attempt to get around the contemporaneous emails and documents that contradict their version of events. They gave non-responsive answers to questions and tried to redirect their cross-examinations by giving the court longwinded explanations about the “context” of what occurred.
[108] The evidence of Ray, Imran and Ken, on the other hand, was straightforward and consistent with the documentary evidence. Any minor inconsistencies or inaccuracies in their testimony do not undermine the plaintiffs’ credibility on the central issues in this trial.
[109] Wherever the evidence of Amar, Sunny and Chamath conflicts with that of Ray, Imran and Ken, I prefer the latter. While in many cases the evidence of Amar, Sunny and Chamath is uncontradicted, it is only because the plaintiffs were not privy to the defendants’ dealings with one another or with third parties.
[110] There are a number of areas on which the evidence of the witnesses conflict. I make the following factual findings, on a balance of probabilities.
The Annex Fund
[111] Ray, Imran and Ken testified that that they trusted Amar and Sunny as managing directors of Fund I. Their evidence is that from the outset, the parties planned to do a series of funds under the Extreme Venture Partners brand. They were supportive of Amar and Sunny taking a lead role in establishing a second EVP fund and proving that they could not only invest capital but also raise it. The plaintiffs also expected that if Amar and Sunny were going to start a new fund on their own, they would do so transparently and properly, by buying out the plaintiffs’ interests in EVP GP under the EVP GP Shareholders’ Agreement.
[112] Amar and Sunny’s evidence is that it was always understood that they could pursue a second fund on their own, without the plaintiffs’ involvement. They testified that Fund I was intended to be a single purpose investment vehicle and that by the time Sunny met Ms. McJannet, Fund I was effectively closed, was not raising or investing new capital, and was waiting for strategic exits. They believed that they were free to establish a second fund and pursue the opportunity with Northleaf on their own.
[113] I do not accept Amar and Sunny’s version of events. The documentary evidence shows that the parties were planning to establish additional funds under the Extreme Venture Partners brand. It is clear from Ray’s email of May 11, 2010 that they were approaching Northleaf to finance another EVP fund. It is clear from the May 2011 Off-Site deck that Amar and Sunny were presenting plans for an “EVP Fund 2” of $30 million, “5x larger then [sic] fund 1, a natural extension to what we have been doing.”
[114] I also accept the plaintiffs’ position that if Amar and Sunny wanted to establish a second fund on their own, they could not do so unilaterally, as that would have been inconsistent with the terms of the EVP GP Shareholders’ Agreement. Section 14.1 precludes the shareholders of EVP GP from operating a business similar to that of EVP GP without the consent of the other shareholders:
Each Shareholder agrees that from and after the date of this Agreement until the date that is six (6) months following the earlier of the date such Shareholder ceases to be a Shareholder or the date of termination of this Agreement […] he shall not in any manner whatsoever, directly or indirectly engage in, carry on or otherwise be concerned with or have any interest in […] any business or enterprise engaged in a business similar to that of [EVP GP Inc.]…anywhere in Canada.
[115] Therefore, if Amar and Sunny wanted to establish a second fund on their own, they were required to obtain the consent of the other shareholders or to exercise their rights under the Shotgun and buy out the plaintiffs’ interests in EVP GP. They did neither.
[116] I find that Amar and Sunny did not tell the plaintiffs that they had established a second EVP fund (or a second fund at all). They did not tell the plaintiffs at the May 2011 Off-Site about their discussions with Northleaf nor did they did tell them that the Annex Fund was established in December 2011. When the plaintiffs asked about rumours of a second fund in 2012 and 2013, Amar and Sunny obfuscated and denied their involvement in operating a new fund. Indeed, Amar had an email exchange with Imran and Ken in May 2013 about what steps Amar and Sunny would have to take if they wanted to establish another funding vehicle under the Extreme Venture Fund name. Imran made it clear that Amar and Sunny would have to compensate the plaintiffs or buy them out or exercise the Shotgun. Amar said nothing in this exchange about the fact that he and Sunny had already been operating the Annex Fund under the Extreme Venture Partners name for almost 18 months by that time.
[117] I further find that Varma Holdco and Madra Holdco (holding companies for Amar and Sunny) agreed to terms in the Annex Fund limited partnership agreement that benefited the Annex Fund, to the detriment of Fund I. Section 4.2 provided that if co-investment rights were available to Fund I limited partners, Varma Holdco and Madra Holdco would cause EVP GP to grant such rights to the Annex Fund in priority to Fund I or other investors. Section 7.9(2) provided that the Annex Fund would only bear incremental administrative expenses that related directly to its own operations and that the Annex general partner and/or Fund I would pay for transaction costs incurred in connection with the Annex Fund’s business. Varma Holdco and Madra Holdco effectively agreed to cause Fund I to guarantee the expenses of the Annex Fund.[^11]
[118] Finally, Fund I had a seat on the board of Local Response, one of the portfolio companies that the Annex Fund invested in. Once the Shotgun was exercised, Sunny sent an email to the CEO of Local Response asking her to change his board seat from Fund I to the Annex Fund. I reject Sunny’s evidence that he was just asking the CEO to add another seat, not to take it away from Fund I. It contradicts the clear language of his email asking for the board seat to be transferred from Fund I to the Annex Fund.
Xtreme Labs
[119] On February 1, 2012, Chamath sent Sunny an email asking him to come to his office to talk about buying Xtreme Labs. The defendants testified that they had no discussions about the acquisition until their dinner in Toronto on March 20, 2012, after which they went to Amar’s apartment for Chamath to draft his offer.
[120] I do not accept their evidence. I find that Chamath, Amar and Sunny worked together and coordinated their efforts to present Chamath’s offer to buy the company at the board meeting on March 21. The defendants’ evidence that they did not talk to one another for six weeks after the February 1 meeting is not credible. It is contradicted by their emails on March 16 that show they were working together on Chamath’s offer to purchase, had brought “key folks” (like Mr. Thawar) on board and were planning the “hammer drop” for the board meeting on Wednesday, March 21.
[121] That is exactly what happened. Chamath, Amar and Sunny worked on the offer the night of March 20. They tightened the time frame for the board to respond, presented a threat to the board and “dropped” it on the board the next day, Wednesday March 21. When Amar presented it to the board, he did not tell the plaintiffs that they had been together the evening before working on the offer. Rather, he and Sunny acted as though they had just received an unsolicited offer from Chamath. They immediately sent a slide deck recommending the offer. They pressured the plaintiffs intensely over the next few days to accept the offer. They tried to resist a valuation of the company and voted against giving the board an M&A mandate.
[122] Why did Amar and Sunny pressure the board to accept Chamath’s offer? Amar testified that they had been bullied into giving up equity in Xtreme Labs by Ken’s 11th hour demand back in 2007. Amar and Sunny were discontent with their compensation and equity in Xtreme Labs and were looking to increase it. They felt their hard work was not being recognized. They resented some of the controls Ray was trying to impose on them.
[123] Chamath was their long time friend. He had the capital and wanted to buy the business. He knew that the mobile world was about to explode. The three friends talked regularly about the technology business. Chamath had supported his friends when Fund I and Xtreme Labs were established in 2007. He knew about Ken’s threat and thought that Amar and Sunny had been taken advantage of. Chamath’s offer to buy the company was Amar and Sunny’s opportunity to increase their equity and compensation in the business they co-founded and to reap the rewards of their hard work. I find that Amar and Sunny were motivated by their self-interest in pressuring the board to do a deal with Chamath.
[124] Moreover, Amar and Sunny worked with Chamath to facilitate his acquisition of Xtreme Labs at a discounted purchase price. They did this, as set out below, by (a) understating the company’s revenue projections; (b) advancing a low earnings multiple; and (c) concealing the company’s equity interest in Hatch Labs.
(a) Revenue Projections
[125] Amar and Sunny testified that when they presented the 2012 business plan to the board in November 2011, the $12 million revenue projection for FY 2012 was reasonable, based on management’s view of the business and the significant challenges it faced. They testified that they still held this view at the time of the Seven Hills valuation in April 2012, seven months into the fiscal year. They knew that the board was relying on these revenue projections as the basis for determining an acceptable purchase price for the company.
[126] In Fracassi v. Cascioli, 2011 ONSC 178, at paras. 251 and 259, Pepall J. (as she then was) noted that forecasts “by their very nature are speculative” and are “intrinsically uncertain and inaccurate.” However, she noted that the speculative nature of a forecast will not protect a defendant in situations in which he “knew that the statement was false or was indifferent to its truth or falsity”. She found in that case that there had been no attempt by the defendants to deceive the plaintiff.
[127] The law requires that directors act reasonably and fairly – not perfectly: Peoples Department Stores Ltd. (1992), Re, 2004 SCC 68, [2004] 3 S.C.R. 461, at paras. 65 and 67. The “business judgment rule” accords deference to a business decision, so long as the decision lies within a range of reasonable alternatives: Pente Investment Management Ltd. v. Schneider Corp. (1998), 1998 CanLII 5121 (ON CA), 42 O.R. (3d) 177 (C.A.). A director’s actions may be protected by the business judgment rule, on the presumption that the director acted on an informed basis, in good faith, and in the best interest of the corporation. Courts will defer to business decisions honestly made: Unique Broadband Systems Inc., Re, 2014 ONCA 538, 121 O.R. (3d) 81, at paras. 45 and 72.
[128] The issue in this case is whether in exercising their business judgment, Amar and Sunny honestly believed that the 2012 projections were reasonable at the time they provided them to Seven Hills in April 2012. I find that they did not.
[129] Amar and Sunny’s testimony that they thought the $12 million projection was reasonable at April 2012 is contradicted by the higher figures they were giving to others around the same time. In November 2011, Sunny told Samsung in his presentation that Xtreme Labs’ projected revenues were $20 million. I do not accept his explanation that this figure (which was 66% higher than the $12 million figure he gave to the board a week before) was just for marketing purposes.
[130] On March 24, Amar told Chamath that projected revenues for 2012/13/14 were $15M/$20M/$30M. I do not accept Amar’s explanation that these were just “pie in the sky” numbers – he did not present them to Chamath that way. These numbers were 25%, 42% and 87% higher, respectively, than the $12/$14/$16 million figures he and Sunny gave to Seven Hills 10 days later. They also projected a much higher growth rate than the 15% rate given to the board and Seven Hills.
[131] In an email dated March 25 about valuation, Amar maintained to Ken that the $12 million projected revenue figure should be used, although “there is an opp to get to $15m depending on the swing of some big deals where we need some influence and connections to close.” In his emails to Chamath and Sunny at the time, Amar stated clearly that revenues were on course to reach $15 million and to grow in the following years, yet he continued to advance the $12/$14/$16 million figures to the board and Seven Hills.
[132] On March 31, Amar told Chamath that Xtreme Labs “on its current course has a ton of momentum.” On April 28, Amar told Sunny that the 2012 revenues were $15 million. The memorandum of understanding sent to Chamath on April 29th repeated the projected revenue figures of $15M/$20M/$30M for 2012/13/14.
[133] The actual revenue figures Amar and Sunny gave to Seven Hills were up to the end of February only. Amar justified the continued use of the $12 million projected revenues on the basis that January and February revenues were low – $795,000 (January) and $817,000 (February). Amar’s evidence is undermined by his email to Chamath dated July 17 in which he said that the first calendar year quarter (January to March) was historically a seasonal slowdown for the company. Moreover, although Amar testified that the first quarter of calendar year 2012 was the worst in the company’s history, its revenues of approximately $2.8 million were 15% higher than revenues for the first quarter of calendar year 2011.
[134] Further, by the time of the valuation, I find that management would have had the March figures, based on their weekly finance reviews.[^12] March revenues were significantly higher ($1.116 million) and showed the revenues heading in an upward direction. Amar and Sunny did not provide those improved March figures to Seven Hills. I also note that the actual revenue figures for October-March FY 2012 were $6.845 million compared to $4.914 million for October-March FY 2011, almost 40% higher by the date of the Seven Hills valuation.[^13]
[135] The defendants’ emails shortly after the Seven Hills valuation further support my view that they knew the company was on a continued growth trajectory and not in the slowdown they presented to the board and Seven Hills. Amar told Chamath on May 4 that he should sign back the letter of intent quickly as the “Sellers may get cold feet as more data comes in.” I reject Amar’s explanation that this language was “just kind of a phrase in discussion and negotiation”, a “figure of speech” and that “data” did not mean financial information for March and April. I find that he was referring to positive financial data that would have shown the company’s continued growth.
[136] Chamath’s email to his friends on June 7 is particularly revealing. He states that the team had done $1.6 million and $1.8 million in revenues in April and May, were on track to do $2-2.5 million per month through the rest of next year and were confident that they would do somewhere between $20-25 million in revenues. He also states that the purchase price for the company was based on a total enterprise value of “~$19M or 1x current year revenues”. Chamath obviously knew when he accepted the board’s offer on April 29 that the 2012 revenues were projected to be significantly higher than the $12 million figure Amar and Sunny had given to Seven Hills a few weeks before.
[137] The actual FY 2012 revenues were $17.2 million. While that is not itself evidence that the projections were unreasonable, the actual revenues were much closer to the figures that Sunny gave to Samsung in November, that Amar gave to Chamath in March and April, and that Chamath gave to his friends in June.
[138] Amar and Sunny testified that the $5.2 million delta between the $17.2 million in actual revenues and $12 million in projected revenues was from the four contracts that arose after the end of April, which is why they were not included in the pipeline information given to Seven Hills (other than the $150,000 NBA opportunity and a zero value for the NFL). Amar did not say exactly when these contracts materialized, only that they all arose some time after the end of April. I note that Amar and Sunny made no reference to these four contracts in the affidavits tendered as their examination in chief – this evidence came up in their testimony at trial. In particular, they made no mention of a lunch with Sheryl Sandberg that resulted in a contract for $3 million. Further, their affidavits state that Facebook, the NFL and the NBA grew as customers after the closing in August 2012 (six weeks before year end), not between May and August as they testified at trial.
[139] Amar and Sunny’s evidence with respect to the additional $5.2 million does not correspond with the evidence on the company’s billing and revenue collection process. According to Mr. Quan, the company practiced milestone billing at that point, so the services to generate the additional $5.2 million would have to be performed before they could be billed and revenue collected. The evidence of the defendants’ expert Mr. Cochran is that at full utilization, each engineer had the capacity to bill $250,000 in revenues per year. Therefore, all of the company’s engineers would have had to be working full time for four months (i.e. by June 1), on top of their other work, to generate these additional revenues by September 30. To the extent that any new engineers had to be brought in to do the work, it would have taken additional time for them to be recruited and trained. Amar and Sunny told Seven Hills that a project typically spends 6 to 8 weeks in the pipeline before actual work begins on it. Mr. Quan testified that the process from execution of a contract to the commencement of work can take weeks or months.
[140] The evidence with respect to employee hiring does not support Amar and Sunny’s projection of slow growth to the board and Seven Hills. Amar testified that from January to March 2012, Xtreme Labs hired eight full time engineers, eight contract workers and 27 co-op students. The commitment to take on 27 co-op students was made in October 2011, around the same time that Amar and Sunny were telling the board that growth was slowing down dramatically. There is no reference to hiring additional engineers or co-op students in the business plan – indeed, the plan refers to the difficulty in employee retention and hiring. Moreover, the total employee number provided to Seven Hills in April 2012 (86) was lower than the total employee number given to Samsung in November 2011 (88) and does not appear to reflect the increased hiring in January to March 2012. Amar testified that the lower number given to Seven Hills in April was due to terminations in late 2011 but provided no evidence to support his testimony.
[141] Finally, in Chamath’s email to Phil Deutch of September 27, 2012, he projected 100% year over year growth for the company. I do not accept his evidence that these figures were all made up as a joke among friends. His 100% growth figure is far more in line with the company’s previous revenue growth rates of over 100% per year than the minimal 15% growth rate that Amar and Sunny forecasted to the board and Seven Hills in April.[^14]
[142] Considering all of the evidence, I find on a balance of probabilities that Amar and Sunny did not honestly believe the projections they gave to the board and Seven Hills in April 2012 were reasonable. To the contrary, I find that Amar and Sunny were optimistic about the business and its potential for continued growth. They knew that there were upcoming projects that would generate significant additional revenues for FY 2012. They downplayed the financial prospects of Xtreme Labs in order to facilitate Chamath’s acquisition of the company at a discounted price.
[143] However, even if I accept that Amar and Sunny believed the $12 million forecast was reasonable as at April 2012, I find that prior to the signing the Redemption and Share Purchase Agreement in July and the closing in August, Amar and Sunny knew that the actual revenues were significantly higher than what they had projected to the board and Seven Hills. They knew that contracts worth an additional $5.2 million had materialized. They provided this information to Chamath – but did not provide it to the board.
(b) Pivotal Multiple
[144] Chamath told his friends in his June 7 email that Pivotal had been sold for $96 million, which was 2.5x current year revenues. This stands in stark contrast to the information he gave the board about the Pivotal transaction in the March 20 offer – $28 million, representing 0.75x current fiscal year projections. At trial, Chamath testified that the appropriate multiple was a range, anywhere from 0.5x to 3x. This range conflicts with the statement to his friends that the multiple was a fixed number (2.5x).
[145] I find that Chamath knew that the multiple was significantly higher than the 0.75x number contained in his offer. Given how closely Amar, Sunny and Chamath were working together at the time, I find that they all knew the Pivotal multiple was higher than the 0.75x number contained in Chamath’s offer on March 20. Amar and Sunny nonetheless conveyed the offer to the board with a number they knew to be understated.
[146] When Ray told Amar and Sunny he understood from Rob Mee that a 3x multiple would be appropriate, they tried to persuade him that it was a lower number. Amar tried to convince Ray that the multiple was 1x revenues. Sunny asked Rob Mee to tell Ray that a 1-1.5 multiple was the right number for a consulting company like Xtreme Labs. Amar also suggested to the board that it rely on a Deloitte report from 2010, which used a revenue multiple of 0.6 to 0.7.
[147] I find that all of these efforts were an attempt by Amar and Sunny (supported by Chamath) to convince the board to accept Chamath’s offer that was based on a low earnings multiple.
(c) Hatch Labs/Tinder
[148] Hatch Labs was a joint venture between Xtreme Labs and IAC established in October 2010. IAC was an existing client of Xtreme Labs. Amar testified that Xtreme Labs agreed to contribute it services on a single project, the Blu Trumpet app, in an effort to secure more work from IAC. When Amar presented this arrangement to the board in 2010, Ken was resistant and thought Xtreme Labs should be paid for its work but the board ultimately agreed and the project proceeded.
[149] Amar was a director of Hatch Labs. He testified that Hatch Labs had an office in New York located in the IAC offices. Amar and Sunny testified that the joint venture was well publicized in the media in 2011 and 2012. They refer to a March 31, 2011 article in TechCrunch, a popular technology publication that was circulated to a distribution list including Ray, Imran and Ken. The article stated that Hatch Labs was financially a joint venture between Xtreme Labs and IAC.
[150] EVP GP sent a 2011 update to Fund I limited partners dated March 31, 2012. Amar and Sunny prepared the update, which Ray reviewed. It states that the strongest asset of Xtreme Labs was its base of engineers but the company was making “a concerted effort to grow the tangible IP contained within the company.” As part of that effort, patents were filed along with “strategic investments in product platforms” including XL Magic, Glooko and “Hatch Labs – a mobile technology sandbox creating products for the billions with mobile devices.”
[151] In fact, Xtreme Labs had a 13% equity interest in Hatch Labs (the other 87% was owned by IAC). Amar and Sunny testified that they fully disclosed this equity interest in Hatch Labs to the board. Ray testified that the board was not told about this equity interest. I accept Ray’s evidence, for the following reasons:
• All of the communications by Amar and Sunny about Hatch Labs were vague – a joint venture, a strategic investment, a contribution of services to obtain more work from an existing customer, a loss leader. There is nothing to support their testimony that they told the board that Xtreme Labs had a 13% equity interest in Hatch Labs;
• Hatch Labs is not referred to in the Xtreme Labs financial statements. Glooko and Extreme Startups, the other companies in which Xtreme Labs had an equity interest, are referred to in the financial statements;
• Hatch Labs is not referred to in the Seven Hills report. Glooko and Extreme Startups are referred to in the report. There is nothing to support Amar’s testimony that he told Seven Hills about the equity interest in Hatch Labs and that they decided not to include it in the valuation. I note that in the Valuation Items list that Amar and Sunny prepared for Seven Hills, they refer to Glooko and Extreme Startups under Related Party Transactions but not to Hatch Labs.
• When the board made its counter-offer to Chamath on March 24, it included a carve out for the company’s shares in Glooko and Extreme Startups. The board did not seek to carve out any equity in Hatch Labs. Ray’s testimony, which I accept, is that this was because the board was unaware of the equity interest in Hatch Labs.
[152] I find, on a balance of probabilities, that Amar and Sunny never disclosed to the board the fact that Xtreme Labs had a 13% equity interest in Hatch Labs. This would have been significant, given management’s view that the way for a fee for service business to get to the next level was through the development of proprietary technology, which is what Hatch Labs was doing.
[153] Chamath also denied knowing anything about Hatch Labs at the time of the sale transaction. He testified that he only learned about Hatch Labs when he was discussing Xtreme Labs’ customers with Amar and Sunny shortly after closing. I do not accept his evidence. Given his close communications with Amar and Sunny and his interest in receiving detailed information about Xtreme Labs from them prior to closing, his testimony that he did not learn about the 13% equity interest in Hatch Labs until after closing is not credible.
[154] My view is supported by a speech that Chamath gave at a Collision Conference in 2014, which was played at trial. In his speech, Chamath described his strategy in acquiring Xtreme Labs, selling it to Pivotal and carving out the Hatch Labs equity and selling it to IAC four months later. He said that he knew that his friend had being developing apps and receiving equity in lieu of payment. He told Pivotal that he valued this equity and wanted to carve it out of the sale. This contradicts his evidence that when he found out about Hatch Labs shortly after closing, he considered it worthless. I find, on a balance of probabilities, that Chamath knew about the equity interest in Hatch Labs at the time of the sale and believed that it had value. That is why he, Amar and Sunny carved it out of the Pivotal sale and sold it to IAC in March 2014.
[155] I now turn to the evidence about Tinder.
[156] In 2012, during the negotiation and sale of Xtreme Labs to Chamath, Hatch Labs was developing an on-line dating app. The app was initially called Matchbox and was later renamed Tinder.
[157] Dinesh Moorjani, the CEO of Hatch Labs, testified about the development of Matchbox/Tinder. He testified that Hatch Labs hosted an internal “hackathon” competition for its employees in February 2012. An on-line dating app called Matchbox won the hackathon and was identified as “overall Winner/Greatest Potential” and “Best product & Tech”. Amar was copied on an email about Matchbox, the winner of the hackathon, on February 23. Sunny was copied on most Hatch Labs emails and was scheduled to interview Sean Rad, the founder of Tinder, for a position at Hatch Labs in February 2012.
[158] On May 9, 2012, there was a directors’ meeting for Hatch Labs. A slide deck was circulated the day before the meeting. It contains a slide with screenshots of a concept known as Matchbox that was “partially built”. Amar says he does not recall seeing the slide deck prior to this litigation and did not share it with Chamath or Sunny. However, he admits that he attended the May directors’ meeting at the IAC offices in New York. Barry Diller, the CEO of IAC (which owned 87% of the shares of Hatch Labs), was a director of Hatch Labs and was at the meeting.
[159] According to Ray, IAC was the largest online dating company in the world at the time and owned the programs “match.com” and “okcupid”. Ray testified that Mr. Diller was regarded as one of the most important and influential leaders on the internet and that meeting with Barry Diller “is like meeting with Bill Gates”. The defendants’ valuation expert Mr. Cochran acknowledged that a relationship with IAC would have had some value in the context of a product being developed in the mobile dating app industry. Amar did not tell the plaintiffs that Barry Diller was in attendance at the directors’ meeting.
[160] Mr. Moorjani testified that in late May/June 2012, Hatch Labs decided to develop the Matchbox concept. By late June, the Matchbox team had developed an alpha version for internal use. In June and July, the team developed a beta version.
[161] On July 17, Mr. Moorjani sent Amar an email about various projects that Hatch Labs was working on. At the end of the email there is a reference to Tinder (which had been renamed from Matchbox by that point), with the note “tbd”. Amar testified that he asked nothing about the reference to Tinder because he did not know about Tinder at the time.
[162] On August 2, 2012, less than two weeks before the closing of the Xtreme Labs sale to Chamath, Tinder was launched in the Apple Store. Amar and Sunny did not tell the plaintiffs about the launch.
[163] Mr. Moorjani testified that although there were some differences, the Tinder app was very similar to the Matchbox concept that won the hackathon in February 2012. In particular, it included the key “double-blind feature” that allowed users to indicate their interest in another person without the fear of rejection.
[164] Mr. Moorjani testified that the initial launch of the Tinder app was considered a failure. An updated version was released in September 2012 containing the “swipe” feature that later became a highly publicized feature of the app. He testified that the early stage metrics for Tinder were not indicative of success and that based on all of the information available about Tinder in August 2012, it would have been impossible to predict that it would ultimately achieve commercial success.
[165] The sale of Xtreme Labs to Chamath closed on August 15, 2012.
[166] In October 2013, the defendants sold Xtreme Labs to Pivotal. Prior to the sale, they carved out the shares of Hatch Labs, Glooko and Extreme Startups (and another company Shifthub) and transferred them to 239 Ontario, owned 50% by El Investco and 25% each by Amar and Sunny. Chamath testified that the only asset of any value in Hatch Labs at the time was Tinder. In March 2014, 239 Ontario sold its interest in Hatch Labs to IAC for USD$30 million. By the time of the sale, the value of Tinder had increased significantly due to its success at the 2014 Sochi Olympics.
[167] Amar, Sunny and Chamath deny that they ever heard about Matchbox/Tinder prior to closing the sale to Chamath. They all testified that they first learned of Matchbox/Tinder some time in 2013.
[168] I do not accept their evidence. Amar was a director of Hatch Labs. He received materials about the company and its projects. He was copied on the February 23 email identifying Matchbox as the “overall Winner/Greatest Potential” and “Best product & Tech”. He received the slide deck for the May 9 directors’ meeting with screenshots about Matchbox. He received an email in July that listed Tinder as one of the apps under development. It is not credible that Amar did not see the references to Matchbox/Tinder in any of these materials.
[169] By May/June 2012 Hatch Labs had decided to develop the app. Over the next three months, there was considerable activity. The concept was rebranded from Matchbox to Tinder, an alpha version was launched, a beta version was launched, and the app itself was launched in the Apple Store. It is not credible that Amar was unaware of any of this activity.
[170] Hatch Labs was 87% owned by IAC, one of the world’s most successful online dating companies. Barry Diller, the CEO of IAC, was a director and at the May 9 meeting with Amar. It is not credible that Amar was unaware that Hatch Labs was in the process of developing a mobile dating app with the support of such a dominant player in the industry.
[171] I find on a balance of probabilities that Amar knew about the development of the Tinder app and its launch in the Apple Store at the time of closing. Given how closely Amar, Sunny and Chamath were working together on the Xtreme Labs transaction, I find that they all knew about Tinder. It is not credible to me that Chamath did not know about Tinder, a mobile dating app, given his extensive knowledge about the internet and his view that the mobile world was about to explode. The defendants’ shared knowledge about Tinder is reinforced by the fact that they subsequently transferred the equity interest in Hatch Labs, whose primary asset was Tinder, to a company that they owned, thereby appropriating the asset to themselves. I note that despite Amar’s position to the board that the employees should be given increased ownership of the Xtreme Labs assets, none of the employees shared in the USD$30 million they received for Tinder.
[172] I find that Amar and Sunny concealed these facts from the plaintiffs and, in so doing, deprived the plaintiffs of the opportunity to take this asset into account as part of the sale transaction.
[173] The defendants argue that no one could have predicted in August 2012 that Tinder would become a great success. There are two problems with this submission. First, it is not consistent with the position advanced by the defendants in their testimony. The defendants did not testify that they were aware of Tinder but failed to disclose it to the board because they thought it had no value at the time. Rather, they testified that they never heard of Tinder until well after the sale transaction. I have rejected their evidence and found that they did know about Tinder at the time of the sale and failed to tell the plaintiffs about it. Second, as fiduciaries, Amar and Sunny had a duty to disclose to the board all of the information with respect to the company’s assets, regardless of whether or not they thought it had the potential for future success at the time. They did not do so.
THE PLAINTIFFS’ CLAIMS
[174] The plaintiffs advance several causes of action with respect to the Annex Fund Claim and the Xtreme Labs Claim. The Annex Fund Claim is brought against Amar, Sunny, Varma Holdco and Madra Holdco, the Annex Fund and Annex GP. The causes of action are breach of fiduciary duty, breach of contract, and passing off.
[175] The Xtreme Labs Claim is brought against Amar, Sunny, Varma Holdco, Madra Holdco, Chamath and El Investco. The causes of action against Amar, Sunny, Varma Holdco and Madra Holdco are breach of fiduciary duty, breach of contract, and conspiracy. The causes of action against Chamath and El Investco are knowing assistance in breach of fiduciary duty, inducing breach of contract, and conspiracy.[^15]
[176] In analyzing the various causes of action, I will identify the plaintiffs that have standing to assert the claim and the defendants who may be liable for the claim.
Preliminary Comment
[177] Many of the defendants’ arguments focused on the individual plaintiffs’ conduct. The defendants argue, for example, that Ray, Imran and Ken did not pursue rumours about a second fund sufficiently; did not make inquiries to confirm management’s financial numbers with Xtreme Labs’ accounting staff; did not put better procedures in place to avoid conflicts in the Xtreme Labs sale transaction; and did not seek a second valuation after Seven Hills delivered its report.
[178] In my view, this case is not about what the individual plaintiffs did or did not do.[^16] This case is not about whether or not they fulfilled their duties as directors of EVP GP and Xtreme Labs.
[179] This case is about the defendants’ conduct and whether or not they fulfilled their fiduciary and contractual duties as directors of EVP GP and Xtreme Labs. It is about whether they conspired with Chamath and concealed information from the plaintiffs.
Standing re Breach of Fiduciary Duty Claims
[180] EVP GP and Fund I claim that Amar and Sunny breached their fiduciary obligations, both with respect to the Annex Fund Claim and the Xtreme Labs Claim.
[181] The defendants argue that Fund I has no standing to advance a claim for breach of fiduciary duty and that only the corporate general partner, EVP GP, can assert this claim. At the same time, they argue that EVP GP has no standing because it does not assert that it suffered any harm – only Fund I alleges that it suffered harm as a result of the breach of fiduciary duty.
[182] The defendants are correct that the directors owe a duty only to the corporate general partner, not to the limited partnership itself: see McGrail v. Phillips, 2018 ONSC 3571, 83 B.L.R. (5th) 271 (Div. Ct.), at para. 33. They are also correct that the limited partnership, not the general partner, is the proper party to bring a claim for harm suffered by the limited partnership: see 872928 Ontario Ltd. v. Gallery Pictures Inc. (1990), 1990 CanLII 6871 (ON SC), 75 O.R. (2d) 273 (C.J. (Gen. Div.)), at pp. 277-278; Covia Canada Partnership Corp. v. PWA Corp. (1993), 1993 CanLII 9429 (ON SC), 105 D.L.R. (4th) 60 (Ont. C.J. (Gen. Div.)), at pp. 73-74, affirmed (1993), 1993 CanLII 9419 (ON CA), 106 D.L.R. (4th) 608 (C.A.).
[183] In this case, Fund I is alleging that it suffered harm as a result of the breach of fiduciary duty owed by Amar and Sunny to its general partner, EVP GP, which was responsible for managing the business of Fund I. While Amar and Sunny owed the fiduciary duty to EVP GP, it is Fund I that is properly bringing the claim and it is Fund I that is entitled to recover the damages for any such breach. In any event, a general partner holds all of the property of the limited partnership: see Hudson's Bay Company v. OMERS Realty Corporation, 2016 ONCA 113, 346 O.A.C. 14, at para. 19. To the extent that EVP GP recovers any amount from Amar and Sunny for breach of their fiduciary duties, that amount is held by EVP GP as property of Fund I. In either case, the damages are recoverable by Fund I, the party that alleges the harm suffered.
[184] The defendants further argue that in the Xtreme Labs Claim, there can be no claim for breach of fiduciary duty owed to EVP GP. They argue that in the Xtreme Labs sale transaction, Amar and Sunny were acting qua directors of Xtreme Labs during the course of the sale transaction, not qua directors of EVP GP. Therefore, they argue, Amar and Sunny owed fiduciary duties to Xtreme Labs and not to EVP GP. Xtreme Labs is the only corporation with standing to bring a claim for breach of fiduciary duty. Since Xtreme Labs is not a party to this transaction, the claim for breach of fiduciary duty must fail.
[185] I reject that submission. Amar and Sunny were directors of both companies. The businesses of Fund I and Xtreme Labs were integrated from the beginning. They were established at the same time, the boards of both EVP GP and Xtreme Labs were virtually identical, there were no separate board meetings, and the business of both Fund I and Xtreme Labs was discussed at these meetings. Fund I owned a significant stake in Xtreme Labs (41.82% at the time of closing) and the actions taken by Amar and Sunny in connection with the sale of Xtreme Labs had a direct impact on its business. I find the defendants are attempting to draw an artificial distinction between Amar and Sunny’s roles as directors of EVP GP and Xtreme Labs. I am satisfied that Amar and Sunny, as directors of EVP GP, owed fiduciary duties to that company in connection with the sale of Xtreme Labs.
The Annex Fund Claim
Breach of Fiduciary Duty
[186] The fiduciary duties owed by Amar and Sunny as directors of EVP GP are defined by statute and common law. Under s. 134(1) of the Business Corporations Act, R.S.O. 1990, c. B.16:
Every director and officer of a corporation in exercising his or her powers and discharging his or her duties to the corporation shall,
(a) act honestly and in good faith with a view to the best interests of the corporation; and
(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
[187] In Peoples, the Supreme Court of Canada described the nature of the statutory fiduciary duty imposed on directors, at para. 35:
The statutory fiduciary duty requires directors and officers to act honestly and in good faith vis-à-vis the corporation. They must respect the trust and confidence that have been reposed in them to manage the assets of the corporation in pursuit of the realization of the objects of the corporation. They must avoid conflicts of interest with the corporation. They must avoid abusing their position to gain personal benefit. They must maintain the confidentiality of information they acquire by virtue of their position. Directors and officers must serve the corporation selflessly, honestly and loyally: see K.P. McGuinness, The Law and Practice of Canadian Business Corporations (1999), at p. 715.
[188] In BCE Inc., Re, 2008 SCC 69, [2008] 3 S.C.R. 560, the Supreme Court of Canada described the fiduciary duty imposed on directors at common law, at para. 38:
The fiduciary duty of the directors to the corporation is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an ongoing concern, it looks to the long-term interests of the corporation. The content of this duty varies with the situation at hand. At a minimum, it requires the directors to ensure that the corporation meets its statutory obligations. But, depending on the context, there may also be other requirements. In any event, the fiduciary duty owed by directors is mandatory; directors must look to what is in the best interests of the corporation.
[189] Amar and Sunny acknowledge that they owed fiduciary duties to EVP GP. However, they submit that the content of that duty must be seen in the context of the surrounding circumstances at the time – namely, that EVP GP was a single purpose vehicle tied to Fund I, the fund was effectively closed by 2010, and it was understood that Amar and Sunny were free to establish a second fund on their own.
[190] I have already rejected Amar and Sunny’s version of events. In particular, I have found that there were plans for establishing future EVP funds and that, in any event, there was no understanding that Amar and Sunny could unilaterally establish a second fund without the plaintiffs’ knowledge or consent. This was reflected in the non-competition provisions of the EVP GP Shareholders’ Agreement, which inform the content of their duties as fiduciaries of EVP GP.
[191] Amar and Sunny were directors of EVP GP and the managing directors of Fund I’s business. They had a duty to do what was in the best interests of Fund I’s business. They had a duty of honesty, a duty not to use their positions to gain personal benefit, and a duty to maintain the confidentiality of information they acquired as managing directors.
[192] In my view, Amar and Sunny breached these fiduciary duties in the following manner:
• They breached their duty of honesty when they failed to disclose to the plaintiffs that they met with Ms. McJannet in 2010, obtained financing from Northleaf for a second EVP fund, and established and operated the Annex Fund from December 2011 onwards.
• They breached their duty of loyalty when they established a second fund in light of the non-competition provisions of the EVP GP Shareholders’ Agreement and did so under the EVP brand, which was an asset held by EVP GP.[^17] They used their positions as managing directors of EVP GP to establish a relationship with Northleaf and establish the Annex Fund, from which they personally benefitted through their sole ownership of the general partner and their limited partnership interests.
• They breached their duty of loyalty when they took the Northleaf opportunity. As managing directors of EVP GP, they had been pursuing financing from Northleaf for a second EVP fund for years. When the opportunity presented itself on meeting with Ms. McJannet, they simply took it for themselves. This was contrary to the principles set out by the Supreme Court of Canada in Canadian Aero Service Ltd. v. O'Malley, 1973 CanLII 23 (SCC), [1974] S.C.R. 592, at pp. 606-607.
• They breached their duty of loyalty when they granted the Annex Fund priority in co-investment opportunities ahead of Fund I and its limited partners and agreed to cause Fund I to guarantee the expenses of the Annex Fund. Sunny also breached his duty of loyalty when he attempted to transfer the Fund I board seat for Local Response to the Annex Fund.
• They breached their duty of confidentiality when they provided Northleaf with confidential information about Fund I, including information about its due diligence process, internal decision making process, and portfolio company monitoring process. I reject Amar and Sunny’s submission that this detailed information about Fund I and its internal workings and strategies was not confidential. I note that when Amar and Sunny gave this information to Northleaf, they marked their communications “Private and Confidential”.
[193] Whether or not Fund I was or was not pursuing new investment opportunities at the time (which the plaintiffs dispute) is irrelevant. As stated in Wilson v. Legacy Private Trust, 2014 ONSC 2070, 15 C.C.E.L. (4th) 247, at para. 114, citing Felker v. Cunningham (2000), 191 D.L.R. (4th) (Ont. C.A.), leave to appeal to S.C.C. refused (2001), 149 O.A.C. 398, “as the fiduciary duty is based on trust, loyalty and confidence, and not on economic cost to the employer, fiduciary employees are not relieved of their fiduciary duties if the business opportunity sought to further their own ends is one that the employer would have been unwilling or incapable of exploring.” A breach of fiduciary duty is a wrong in itself, regardless of whether a loss can be forseen: Canson Enterprises Ltd. v. Boughton & Co., 1991 CanLII 52 (SCC), [1991] 3 S.C.R. 534, at p. 553. See also Unique Broadband, at para 64.
Breach of Contract
[194] The parties to the EVP GP Shareholders’ Agreement are Ray, Imran, Ken, Varma Holdco, Madra Holdco and EVP GP. Amar and Sunny did not enter into that agreement in their personal capacities. Any breach of contract claim under the EVP GP Shareholders’ Agreement can only be asserted by Ray, Imran, Ken and EVP GP against Varma Holdco and Madra Holdco.
[195] As noted above, s. 14.1 of the EVP GP Shareholders’ Agreement contains a non-competition clause that precludes the shareholders from engaging in “any business or enterprise engaged in a business similar to that of [the GP]. Varma Holdco and Madra Holdco became the sole shareholders of the Annex GP, which managed the business of the Annex Fund. There is no question that the Annex Fund engaged in a business similar to that of Fund I, as it invested in six of the same portfolio companies as Fund I. That constitutes a breach by Varma Holdco and Madra Holdco of their non-competition obligations under the EVP GP Shareholders’ Agreement.
[196] Section 14.2 of the EVP GP Shareholders’ Agreement contains strict confidentiality provisions. Varma Holdco and Madra Holdco breached those confidentiality obligations when, through Amar and Sunny, they provided confidential information about Fund I’s business to Northleaf.
Passing Off
[197] The plaintiffs claim that Amar and Sunny are liable for the tort of passing off. The test for passing off was adopted by the Supreme Court of Canada in Ciba-Geigy Canada Ltd. v. Apotex Inc., 1992 CanLII 33 (SCC), [1992] 3 S.C.R. 120. The necessary components are: (a) existence of goodwill or reputation; (b) deception of the public due to a misrepresentation; and (c) actual or potential damage to the plaintiff.
[198] The evidence with respect to this cause of action is limited. The evidence on the goodwill or reputation of the EVP brand in the marketplace consists only of Ray’s testimony and evidence from one investee company, Locationary.
[199] The evidence on deception of the public comes only from Locationary. There is no evidence from any other investee company or from Northleaf to support the plaintiffs’ claim that the public was deceived by the establishment of the Annex Fund. Considering the limited evidence before me, I conclude that the plaintiffs have not met their evidentiary burden in establishing the tort of passing off.
The Xtreme Labs Claim
Breach of Fiduciary Duty
[200] As noted above, Fund I held a significant share position in Xtreme Labs. Fund I sold its shares to Chamath’s company El Investco in the Xtreme Labs sale transaction. Fund I alleges that Amar and Sunny breached their fiduciary duties as directors of Fund I’s general partner (EVP GP) in connection with the Xtreme Labs sale transaction. I agree.
[201] Amar and Sunny were in a conflict of interest position. They knew that if Chamath acquired Xtreme Labs, they would be staying on with the company, would continue to own their shares and would increase their equity and compensation. Their conflict increased further when they agreed to contribute to the purchase price. However, at all times prior to closing, Amar and Sunny were directors of EVP GP and were obligated to fulfill their fiduciary duties in determining whether a sale was in the best interests of Fund I. Amar and Sunny failed to discharge those fiduciary duties.
[202] They were not transparent with the EVP GP board. Amar and Sunny worked with Chamath on his March 20 offer that contained a threat to set up a competitive business and hire them away from the business, but did not disclose this fact to the board. Instead, they conducted themselves as if they had just received an unsolicited offer from Chamath and then used the threat in Chamath’s offer to try to convince the board to accept the offer.
[203] This was deceptive. The board was entitled to know the role Amar and Sunny were playing with respect to Chamath’s offer from the outset. Amar and Sunny also did not disclose to the board that they were having ongoing discussions with Chamath throughout the negotiations, updating him about internal board discussions and timing, and providing him with monthly revenue figures and company information. They tried to control the board’s communications with Chamath while freely engaging in their own communications with him. Further, they did not disclose to the board that they were contributing funds to the transaction and had become part of the buying group. Their failure to disclose the existence and extent of their conflict was a breach of their duty of honesty.
[204] Even if Amar and Sunny had fully disclosed their role and interest in the transaction, however, they were not relieved from their duty of loyalty to EVP GP: Levy-Russell Ltd. v. Tecmotiv Inc. (1994), 13 B.L.R. (2d) 1 (Ont. C.J. (Gen. Div.)), at para. 596.
[205] In my view, Amar and Sunny breached their duty of loyalty in the following ways:
• They worked with Chamath on the March 20 offer that included terms that were contrary to EVP GP’s interests and favoured those of Chamath –the threat, the tightening of the deadline, and the additional escrow condition.
• They gave different (and higher) projected revenue figures to Chamath than they gave to the board and Seven Hills at the same time.
• They tried to convince the board not to obtain a valuation for Xtreme Labs. A valuation was clearly in EVP GP’s interests as it would enable the board to evaluate whether an offer to purchase Fund I’s shares of Xtreme Labs was or was not acceptable.
• They tried to block the ability of the board to seek other offers by voting against a board M&A mandate and auction process. They consistently pressured the board to accept Chamath’s offer.
• They assisted Chamath in acquiring Xtreme Labs for the most favourable price rather than seeking to obtain the best sale price for EVP GP. They did this by providing Seven Hills with understated revenue projections, failing to provide actual March revenues and not fully disclosing the contracts and opportunities in the pipeline. They further tried to convince the board to use a low revenue multiple figure in determining what would be an acceptable purchase price.
• They reported to Chamath on the internal board dynamics and the positions of the individual plaintiffs with respect to his offer.
[206] Amar and Sunny further breached their duty of honesty when they failed to tell the board before closing that the actual revenues were significantly higher than the projections previously provided to the board and Seven Hills and that Xtreme Labs had entered into additional contracts that generated this revenue.
[207] They further breached their duty of honesty when they concealed the existence of Xtreme Labs’ equity interest in Hatch Labs and the Tinder app that was developed and launched prior to closing.
[208] Amar and Sunny further preferred their own self-interests to those of EVP GP in the sale transaction. They knew that their best future prospects were with Chamath. They did what they could to ensure that Chamath acquired Xtreme Labs at a favourable price, rather than doing what was best for Fund I and seeking the maximum sale proceeds for its shares of Xtreme Labs.
[209] Finally, Amar and Sunny breached their duty of confidentiality by disclosing information about Xtreme Labs to Chamath, before the Redemption and Share Purchase Agreement was signed on July 13 and even before the letter of intent was signed by Chamath on May 8. This duty of confidentiality is informed by the strict confidentiality provisions of the XL Shareholders’ Agreement and the EVP GP Shareholders’ Agreement that broadly define “Confidential Information” as “all information pertaining to or concerning [Xtreme Labs] [EVP GP], its business, assets and undertaking, including its intellectual property.”
[210] Amar and Sunny did not tell the board members that they were providing this information about Xtreme Labs to Chamath nor did they request the plaintiffs’ consent. Chamath did not sign a non-disclosure agreement. I note that when Ray was planning discussions with CGI about a possible acquisition of Xtreme Labs in January 2012, Amar sent him a non-disclosure agreement for CGI to sign.
[211] On March 24, Chamath requested information about the Xtreme Labs organization review, detailed HR review, attrition plan and strategic plan. This was detailed, confidential information that Chamath would not have been entitled to receive by virtue of Hello Warrior’s minimal interest as a limited partner of Fund I and shareholder of Xtreme Labs.[^18] For example, the updates to Fund I limited partners about its portfolio companies only listed the total number of each company’s employees, not the detailed breakdown requested by Chamath. Further, when Ray gave information about Xtreme Labs to investment banks and advisors, it was prior annual revenue information and customer names, not detailed internal HR information. The plaintiffs have satisfied their burden of establishing that the information requested by Chamath was confidential: see GasTOPS Ltd. v. Forsyth, 2009 CanLII 66153 (Ont. S.C.), at para. 124, affirmed, 2012 ONCA 134, 288 O.A.C. 201.
[212] Amar told Chamath he could give him the requested information and Sunny said he could walk Chamath through it the next day. I do not accept the defendants’ evidence that Chamath did not receive this information until after closing. Chamath admitted that there was a power dynamic among the friends and it is evident that Amar and Sunny complied with Chamath’s requests and instructions. I find that Chamath felt entitled to ask for whatever information he wanted about Xtreme Labs and Amar and Sunny gave it to him.[^19] Chamath’s evidence that he had no interest in financial information about Xtreme Labs because he was buying the company for strategic reasons is not credible or consistent with his emails to Amar and Sunny at the time.
[213] I further find on a balance of probabilities that Amar and Sunny provided confidential information to Chamath well before March 24. Sunny and Chamath were in South Korea together in November 2011 when Sunny made the presentation to Samsung. They met in Silicon Valley shortly thereafter, on February 1. Chamath came up to Toronto on March 20 to prepare an offer at $12 million, apparently without receiving any information about the company in advance. I find that highly implausible. Given the close relationship among the friends and the ongoing communication between them, I find that Amar and Sunny gave Chamath information about Xtreme Labs that he in turn used to make his $12 million offer for the company.
[214] Amar and Sunny continued to disclose confidential information to Chamath before the Redemption and Share Purchase Agreement was signed on July 13, 2012, without the plaintiffs’ consent or a non-disclosure agreement in place. That information included actual monthly revenue and EBITDA figures. Chamath admitted on cross examination that he received these figures from Amar and that monthly revenues were not public information. Mr. Cochran confirmed that monthly revenues for private companies are typically regarded as confidential information. Chamath received this confidential information and even forwarded it to his friends on June 7, 2012, before the Redemption and Share Purchase Agreement was signed. The plaintiffs were not asked for (and did not provide) their consent to any of this disclosure.
Breach of Contract/Breach of Warranty
[215] The plaintiffs allege that Amar and Sunny breached various representations and warranties in the Redemption and Share Purchase Agreement (the “RSP Agreement”) signed on closing. The “Vendors” under that agreement included Fund I, Ray, Imran and 2006 Teslia Family Trust. El Investco was the Purchaser and Amar and Sunny were referred to as the “Founders” of Xtreme Labs.
[216] Ken did not own any shares in Xtreme Labs at the time of the transaction – his shares were held in the name of 2006 Teslia Family Trust, which was one of the Vendors under the RSP Agreement. I accept the defendants’ submission that because Ken was not a party to the RSP Agreement, he has no standing to bring a claim for breach of warranty under that agreement. The only parties in this action that have standing to assert a claim for breach of warranty are Fund I, Ray and Imran.
[217] Amar and Sunny represented and warranted to the Vendors in s. 3.2(b) that:
Except as set forth in Schedule C or as part of the Reorganization or pursuant to this Agreement, there has not been, since January 31, 201[2],[^20] any Material Change.
[218] The term “Material Change” is defined as “any change, event or effect in the business, operations, capital, properties, assets, prospects or condition, financial or otherwise, of [Xtreme Labs] that, individually or when taken together, materially affects or could reasonably be expected to materially affect [Xtreme Labs] or any of its Subsidiaries, the Business or the value of the Purchased Shares… “
[219] In Section 3.2(d), Amar and Sunny represented and warranted to the Vendors that:
Material Contracts – Other than as disclosed in the Schedules to this Agreement, none of the Founders, the Corporation or each of its Subsidiaries have entered into any agreements, understandings, negotiations or discussions, whether oral or written in respect of any Material Contracts which will in any way have a material effect on the business of [Xtreme Labs] or the value of the Purchased Shares, excluding any agreements, understandings, negotiations or discussions, whether oral or written with third parties introduced to the Founders, the Corporation and each of its Subsidiaries by the Purchaser.
[220] The term “Material Contracts” is defined as “any agreement or contract, including any group or series of contracts with a third party or related third parties, that is material to the Business, operations, properties, assets, conditions, financial or otherwise, of the Corporation and each of its Subsidiaries, including any agreement or contract that:
(i) requires payment by or to the Corporation or any of its Subsidiaries of an amount in excess of $150,000 in any one year period;
[221] As noted above, Amar testified that the delta between the 2012 actual revenues of $17.2 million and the projected revenues of $12 million were accounted for by four contracts totaling $5.2 million, all of which arose some time after April 2012.[^21] On Amar’s own evidence, each of those contracts was for well over $150,000[^22] and was entered into after January 31, 2012.[^23] The contracts were not disclosed to the Vendors, nor was the revenue generated from those contracts.
[222] Materiality is to be considered from the perspective of the party for whose benefit the contract term is for: Mull v. Dynacare Inc. (1998), 1998 CanLII 14814 (ON SC), 44 B.L.R. (2d) 211 (Ont. C.J. (Gen. Div.)). From the perspective of the Vendors, contracts entered into after January 31, 2012 that would have accounted for an additional $5.2 million in revenues (representing an additional 43% over the $12 million projected revenue figure that Amar and Sunny provided) would be material.[^24] I reject the defendants’ submission that contracts with customers, particularly those of such significant value, were not intended to be included in the definition of Material Contracts. Indeed, that is precisely the type of information that would be material to the Vendors in assessing whether or not they were receiving a fair purchase price for their shares. Amar and Sunny’s failure to disclose these additional contracts and the revenues generated from them is a failure to disclose Material Contracts pursuant to s. 3.2(d) and a Material Change pursuant to s. 3.2(b).
[223] Amar and Sunny’s failure to disclose the launch of Tinder in the Apple Store two weeks before closing is also a breach of warranty in s. 3.2(b). In my view, the launch of a mobile dating app developed in partnership with a dominant player in the industry constitutes an “event … in the business … assets, prospects or condition, financial or otherwise, of the Corporation that …could reasonably be expected to materially affect [Xtreme Labs] or any of its Subsidiaries, the Business or the value of the Purchased Shares.”
[224] Amar and Sunny rely on the representation and warranty of the Vendors contained in s. 3.3(g) of the RSP Agreement:
Each Vendor has received all the information it considers necessary or appropriate for deciding whether to dispose of the [shares of Xtreme Labs] pursuant to this [SPA], and further represents that it has had an opportunity to ask questions and receive answers from [Xtreme Labs] and its management regarding the business, properties, prospects and financial condition of [Xtreme Labs] and each of its Subsidiaries.
[225] They submit that the Vendors knew that the RSP Agreement did not contain financial information for Xtreme Labs for April, May or June 2012 and could have asked for it. Amar and Sunny argue that the Vendors are therefore precluded by s. 3.3(g) from asserting a claim with respect to the non-disclosure of any financial information of Xtreme Labs after March 2012. I reject that submission. The Vendors were entitled to rely on the representations and warranties given by Amar and Sunny with respect to the financial status of Xtreme Labs after January 31, 2012 and, in particular, the representations that there had been no Material Changes or Material Contracts since January 31, 2012. To the extent that Amar and Sunny failed to disclose that information to the Vendors, they cannot avail themselves of the protection afforded by s. 3.3(g).
[226] The plaintiffs further claim that Amar and Sunny breached the confidentiality clauses in the various agreements for Xtreme Labs and Fund I. As noted above, only Varma Holdco and Madra Holdco are parties to these agreements, not Amar and Sunny personally. Given my finding that Amar and Sunny disclosed confidential information about Xtreme Labs to Chamath, this constituted a breach by Varma Holdco and Madra Holdco of their confidentiality obligations under s. 14.2 of the XL Shareholders’ Agreement and the parallel provision (s. 14.2) of the EVP GP Shareholders’ Agreement.
Knowing Assistance in Breach of Fiduciary Duty
[227] The plaintiffs allege that Chamath knowingly assisted Amar and Sunny in breach of their fiduciary duties.
[228] The elements of the tort of knowing assistance in breach of fiduciary duty are set out in Air Canada v. M & L Travel Ltd., 1993 CanLII 33 (SCC), [1993] 3 S.C.R. 787, at p. 825:
• There must be a fiduciary duty;
• The fiduciary must have breached that duty fraudulently and dishonestly;
• The stranger to the fiduciary relationship must have had actual knowledge of both the fiduciary relationship and the fiduciary’s fraudulent and dishonest conduct; and
• The stranger must have participated in or assisted the fiduciary’s fraudulent and dishonest conduct.
[229] In the context of a tort for knowing assistance, the use of the term fraudulent “does not signify that an additional degree of corruption is necessary to make out the tort; it simply emphasizes the required dishonest quality of the fiduciary’s act”: Enbridge Gas Distribution Inc. v. Marinaccio, 2012 ONCA 650, 355 D.L.R. (4th) 333, at para. 27, leave to appeal to S.C.C. refused, 320 O.A.C. 396. The type of conduct captured by the two terms used together is described as “the taking of a knowingly wrongful risk resulting in prejudice to the beneficiary”: Air Canada, at p. 826.
[230] Amar and Sunny were directors and fiduciaries of EVP GP. Chamath was aware of their role with EVP GP, as he agreed to support them in establishing Fund I and Xtreme Labs in 2007 and had remained in close contact with them. He knew they were fiduciaries of that company.
[231] Chamath testified that he did not know what information and communications Amar and Sunny had with other board members. Chamath’s evidence is contradicted by his email to Sunny on March 16 instructing him what to tell the board about the Pivotal multiplier. It is also contradicted by the ongoing communication between the friends as to what was transpiring among board members.
[232] The plaintiffs allege that Chamath knowingly assisted Amar and Sunny in breaching their fiduciary duties by putting forth a multiplier for Pivotal that they knew was understated and by withholding material information from the board while it was negotiating and entering into the sale transaction with Chamath.
[233] Chamath knew that the Pivotal multiplier was higher than the 0.75x figure he included in his March 20 offer. In fact, he represented to his friends that it was 2.5x revenues. He, Amar and Sunny worked together on an offer that included a Pivotal multiplier figure that they knew was understated. Chamath sent this offer to Amar and Sunny to present to the board. He knowingly participated in their advancing an understated multiplier figure to the board. Chamath therefore assisted Amar and Sunny in breaching their duty of honesty.
[234] On April 29th, Amar and Sunny prepared a letter of intent for Chamath to sign. On May 4, Amar wrote Chamath and asked him to “kickstart the legals quickly” because “the Sellers may get cold feet as more data comes in.” It is evident that Amar wanted to solidify the deal at the $18 million price before additional financial information became available that might cause the plaintiffs to back out of the deal or seek a higher purchase price. Chamath did not challenge that statement or the implication that Amar and Sunny wanted to complete the deal before the plaintiffs had additional financial information about Xtreme Labs. Rather, he responded that he would have the letter of intent signed right away and proceeded to sign and return it. In so doing, he knowingly assisted Amar and Sunny in breaching their duty of honesty.
[235] Based on my findings of fact, I further conclude that Chamath knowingly assisted Amar and Sunny in breaching their duty of honesty with respect to Hatch Labs/Tinder.[^25] Amar and Sunny did not disclose the existence of the equity interest in Hatch Labs or the launch of Tinder to Fund I prior to closing. Chamath knew about Hatch Labs/Tinder and, along with Amar and Sunny, proceeded (through El Investco) to close the transaction on the basis of this concealed information. In so doing, Chamath knowingly assisted Amar and Sunny in the breach of their fiduciary duty.
Inducing Breach of Contract
[236] The tort of inducing breach of contract has four elements, as set out in Drouillard v. Cogeco Cable Inc., 2007 ONCA 322, 86 O.R. (3d) 431, at para. 26:
• There is a valid and enforceable contract;
• The defendant is aware of the existence of the contract;
• The defendant intended to and did produce the breach of the contract; and
• As a result of the breach, the plaintiff suffered damages.
[237] The plaintiffs claim that Chamath induced Varma Holdco and Madra Holdco to breach their contractual obligations under the XL Shareholders’ Agreement. I am satisfied that the elements of this tort have been met. The XL Shareholders’ Agreement was valid and enforceable. I reject the argument that the obligations under that agreement merged on closing. The confidentiality obligations in the XL Shareholders’ Agreement were independent of the purchase transaction and were not superseded by the terms of the RSP Agreement. I also find that Fund I, Ray and Imran did not release the defendants from any breach of those confidentiality obligations. The form of release signed on closing specifically excludes any claims arising by way of “willful misconduct” or “illegal conduct.”
[238] I find that Chamath was aware of the XL Shareholders’ Agreement as his family trust, Hello Warrior, agreed to be bound by it when Hello Warrior acquired a small shareholding in Xtreme Labs.
[239] I find that Chamath intended to and did procure the breach of the XL Shareholders’ Agreement when he asked Amar and Sunny to provide him confidential information of Xtreme Labs prior to signing the letter of intent on May 8, 2012. Finally, as set out below, Fund I, Ray and Imran suffered damages as a result of the breach.
Conspiracy
[240] The Supreme Court of Canada in Cement LaFarge v. B.C. Lightweight Aggregate, 1983 CanLII 23 (SCC), [1983] 1 S.C.R. 452, at p. 471 recognized the tort of conspiracy in cases “where the conduct of the defendants is unlawful, the conduct is directed towards the plaintiff … and the defendants should know in the circumstances that injury to the plaintiff is likely to and does result.”
[241] The test for unlawful conduct conspiracy was expanded upon in Agribrands Purina Canada Inc v. Kasamekas, 2011 ONCA 460, 106 O.R. (3d) 427, at para. 26:
• They act in combination, in concert, by agreement or with common design;
• Their conduct is unlawful;
• Their conduct is directed towards the plaintiff;
• The defendants should know that, in the circumstances, injury to the plaintiff is likely to result; and
• Their conduct causes injury to the plaintiff.
[242] Conspiracy claims are often built on inference, as it is difficult to prove them by direct evidence: Canadian Community Reading Plan Inc. v. Quality Service Programs Inc. (2001), 2001 CanLII 24156 (ON CA), 141 O.A.C. 289 (C.A.), at para. 27, citing Paradis v. R. (1933), 1933 CanLII 75 (SCC), [1934] S.C.R. 165.
[243] In Levy-Russell, at paras. 588-589, the court found, on the facts of that case, a conspiracy between defendant directors and a potential purchaser to acquire the company’s assets at below market price.
[244] For the reasons set out above, I have found that Chamath, Amar and Sunny worked together for Chamath (through El Investco) to acquire the shares of Xtreme Labs at an undervalued price and concealed an asset of the company from the selling shareholders. On the facts of this case, the plaintiffs have satisfied the elements of unlawful conduct conspiracy.
[245] While it is not entirely clear when the conspiracy began, the evidence is that at the very latest by February 1, 2012, Chamath, Amar and Sunny began to act in concert to acquire the shares of Xtreme Labs held by the plaintiffs. That is when Chamath called Sunny to his office to talk about the purchase and the three friends started to plan and implement the acquisition over the ensuing months.
[246] Chamath’s evidence at the Town Hall meeting with the employees in September 2012 supports this timing. He stated “over the course of this last year, you know, sort of instigating and pushing and prodding, we finally found the path to basically buy Xtreme and recapitalize it.”[^26] In his speech at the Collision Conference in 2014, he confirmed that he had been talking about Xtreme Labs when he said that his friend got screwed over by his investors so “he and I basically put together a deal and we took this company private.” He said that “we went to the investors and we said you have 24 hours, you’re selling me this company or I’m going to basically hire every single person, we’re going to steal every single contract, so take the 12 million bucks and pound sand.” The defendants were clearly acting in concert.
[247] With respect to the second element, an actionable tort constitutes unlawful conduct in the context of a conspiracy claim: Agribrands, at para 37. I have already determined that Amar and Sunny breached their fiduciary duties to Fund I and breached their warranties to Fund I, Ray and Imran under the RSP Agreement. Varma Holdco and Madra Holdco breached their contractual obligations under the XL Shareholders’ Agreement and the EVP GP Shareholders’ Agreement. Chamath knowingly assisted in Amar and Sunny’s breach of fiduciary duties and induced the breach of the XL Shareholders’ Agreement. Chamath incorporated El Investco to complete the purchase. All of those parties worked together to close the transaction while concealing the existence of Hatch Labs from the selling shareholders. The unlawful conduct element is satisfied.
[248] With respect to the third and fourth elements, Chamath, Amar and Sunny knew that Fund I, Ray and Imran held shares in Xtreme Labs. Chamath, Amar and Sunny would have known that any effort on their part to buy the company at an undervalued price would squarely impact those plaintiffs and result in injury to them.
[249] Finally, as set out in the damages section below, the conduct of Chamath, El Investco, Amar and Sunny caused Fund I, Ray and Imran to sustain losses on their sale of shares of Xtreme Labs.
Limitations Defence
[250] The defendants have raised three limitations defences. Amar and Sunny submit that the plaintiffs knew or ought to have known about the Annex Fund by May 2012 and that the plaintiffs’ claim, which was issued on July 21, 2014, is statute-barred. I have found that Amar and Sunny concealed the existence of the Annex Fund and denied that they had set up a new fund. The plaintiffs did not discover the existence of the Annex Fund until after they exercised the Shotgun in November 2013. The Annex Fund Claim is not statute-barred.
[251] Amar and Sunny submit that the Xtreme Labs Claim is also statute-barred because Ray accused them of being conflicted in March 2012. I disagree. Ray made that comment when he saw that Chamath was making an offer in which Amar and Sunny would stay on as management. The plaintiffs had no reason to know or suspect the wrongful conduct that Amar and Sunny were engaging in with Chamath at that time. They did not discover it until after the Shotgun transaction in November 2013. The Xtreme Labs Claim is not statute-barred.
[252] Chamath submits that the claims for inducing breach of contract and knowing assistance in breach of fiduciary duty are statute-barred because they were included in an Amended Fresh as Amended Statement of Claim delivered shortly before trial. The plaintiffs submit that they included these additional claims following Chamath’s unsuccessful summary judgment motion in which the motions judge made comments about how the conspiracy claim had been pleaded. The plaintiffs amended the claim to include these torts as the constituent elements of the conspiracy claim. In my view, all of the material facts giving rise to these claims had already been pleaded. There is no basis to hold that these claims are statute-barred.
DAMAGES
The Annex Fund Claim
[253] The plaintiffs claim that Ray, Imran and Ken sustained damages for reputational harm as a result of Amar and Sunny establishing the Annex Fund. The plaintiffs also claim that Fund I suffered damages for lost opportunities as a result of the Annex Fund investing in Fund I’s six most successful portfolio companies.[^27]
[254] The plaintiffs tendered evidence from two experts to support their claim for damages. One expert is Stephan May of Welch Group, who concluded that Fund I suffered damages for lost opportunities.[^28] However, Mr. May was unable to quantify these damages because he said that the information on the portfolio companies was incomplete and not reliable. His report therefore does not assist me in quantifying damages.
[255] The plaintiffs’ other expert is Robert Ferguson of BDO Canada. Mr. Ferguson quantified the damages for reputational harm at between $1,555,000 and $5,804,000. He quantified the damages for lost opportunity at $909,122.
[256] With respect to reputational harm, Mr. Ferguson measured damages based on numerous assumptions that Ray provided. A principal assumption was that “but for” the establishment of the Annex Fund, Ray, Imran and Ken would have raised an additional $50 million from institutional investors to create a new fund (the “$50 million assumption”). This assumption was based on a comparison of Fund I to a similar venture capital fund in Montreal called Real Ventures that was established in 2007 with $5 million of initial capital and raised over $50 million as of October 2010. Mr. Ferguson testified that the $50 million assumption was based solely on information he obtained from Ray and that he did not otherwise verify the foundation for his assumption.
[257] The defendants rely on the expert evidence of Andrew Cochran of Ernst & Young. He noted that Mr. Ferguson did not consider industry, market and company specific factors relevant to the $50 million assumption. Mr. Cochran also found it to be a very aggressive assumption. Mr. Ferguson agreed.
[258] Mr. Cochran observed that from 2006 to 2018 an average step-up multiple from a first to second fund was 1.65. Since Fund I raised $5.9 million, it would have been reasonable to expect a second fund to raise $9.735 million. Ray raised over $10 million for EVP Fund II and therefore outperformed the industry norm. Mr. Cochran concluded that Real Ventures was an outlier in the industry.
[259] The only factual evidence I have with respect to reputational harm is Ray’s testimony. He testified that after he discovered the existence of the Annex Fund, he learned that there had been confusion about what was happening at Extreme Venture Partners, causing questions and doubts (especially among the institutional community) as to what had happened. He testified that he, Imran and Ken were viewed as first time fund managers and that Fund I’s reputation was harmed in the eyes of Northleaf and other institutional investors, who did not want to consider proposals to invest with the plaintiffs. However, there is no evidence from any institutional investor to support Ray’s testimony or to confirm that the plaintiffs’ failure to attract institutional funds was due to the existence of the Annex Fund.
[260] Given the insufficient foundation for the $50 million assumption and the lack of evidence to support Ray’s testimony, I conclude that Ray, Imran and Ken have not met their burden of establishing that they suffered reputational damage as a result of the operation of the Annex Fund.
[261] With respect to Fund I’s damages for loss of opportunities, Mr. Ferguson used a dilution analysis approach. He assumed that “but for” the existence of the Annex Fund, Fund I would have maintained its equity percentage in the investee companies that Annex Fund also invested in. There are a number of problems with this analysis. For example, the defendants submit that Mr. Ferguson’s calculation is overstated because Fund I would have been diluted on subsequent investment rounds by any investors, not just by the Annex Fund. Mr. Cochran further pointed out that to accurately calculate damages based on a “no dilution” assumption, one has to know the value and price for each round of financing, and that information was not available. He also observed that Mr. Ferguson did no analysis of the assumption that Fund I could have raised the funds to maintain its ownership position and avoid dilution. Mr. Ferguson admitted that he relied only Ray’s evidence that it was a possibility that Fund I could have raised an additional USD$1 million to avoid dilution.
[262] Mr. Cochran conducted his analysis based on the actual profits or losses approach, which he said is the most common approach in an analysis for lost opportunity damages. He noted that the Annex Fund lost $361,000 and that Varma Holdco and Madra Holdco sustained losses, including the capital they invested. He did not agree with Mr. Ferguson’s “but for” approach, as he said it is too speculative and builds on too many assumptions – for example, that one knows the optimal time to exit and the optimum return to receive.
[263] I accept Mr. Cochran’s actual profits or losses analysis. It is clear and does not rest on the numerous assumptions that underlie the dilution analysis.[^29] The result is that Fund I has not established that it suffered any compensatory damages in the Annex Fund Claim.
[264] The plaintiffs seek an award of punitive damages against Amar and Sunny with respect to their conduct in the Annex Fund Claim. They seek punitive damages in the amount of $1 million. I agree that an award of punitive damages is warranted.
[265] In Whiten v. Pilot Insurance Co., 2002 SCC 18, [2002] 1 S.C.R. 595, the Supreme Court of Canada describes the purpose of an award of punitive damages, at para. 36:
Punitive damages are awarded against a defendant in exceptional cases for “malicious, oppressive and high-handed” misconduct that “offends the court’s sense of decency”: Hill v. Church of Scientology of Toronto, 1995 CanLII 59 (SCC), [1995] 2 S.C.R. 1130, at para. 196. The test thus limits the award to misconduct that represents a marked departure from ordinary standards of decent behaviour. Because their objective is to punish the defendant rather than compensate a plaintiff (whose just compensation will already have been assessed), punitive damages straddle the frontier between civil law (compensation) and criminal law (punishment).
[266] In Whiten, at para. 111, the Supreme Court states that proportionality is the key to the permissible quantum of damages. Retribution, denunciation and deterrence are the recognized justification for punitive damages, which must be rationally proportionate to these purposes. The punitive damages award must be proportionate to the level of blameworthiness of the defendant’s conduct, the degree of vulnerability of the plaintiff and the harm or potential harm directed at them, the need for deterrence, and the gain wrongfully obtained through the defendant’s misconduct: Whiten, at paras. 111-126.
[267] In the case of the Annex Fund Claim, I have determined that although Amar and Sunny breached their fiduciary obligations, the plaintiffs have not met their burden of establishing compensatory damages.
[268] However, Amar and Sunny’s conduct is most deserving of this court’s sanction. The purpose of a punitive damage award in this case is to denounce Amar and Sunny’s conduct and to deter other fiduciaries from engaging in such misconduct. In my view, a significant award in favour of Fund I is required and is rationally proportionate to these purposes, for the following reasons:
• Amar and Sunny were the managing directors of Fund I. They were the ones in charge. They were the ones entrusted with managing all aspects of Fund I’s operations. The 29 investors in Fund I that Ray, Imran and Ken brought in relied on Amar and Sunny to manage the investment funds and to act in the investors’ best interests.
• This was a high stakes world. The investors put $5.9 million into Fund I. The parties were looking to establish even larger EVP funds and to attract significant amounts from institutional investors. Amar and Sunny obtained $5 million from Northleaf for the Annex Fund.
• Amar and Sunny took the Northleaf opportunity for themselves, knowing that they had been pursuing Northleaf for a future EVP fund for well over a year. Their conduct was planned, deliberate and self-interested.
• They operated the Annex Fund at the same time that they purported to act in the best interests of Fund I. They continued this breach of fiduciary duty for a sustained period of time, from December 2011 to December 2013.
• They shared their inside knowledge about Fund I’s investing strategy and portfolio companies with Northleaf and used that knowledge to establish the Annex Fund for the sole purpose of investing in the winners of the Fund I portfolio.
• Amar and Sunny did not tell the plaintiffs about the Annex Fund and when asked about the rumours, denied that they had established a second fund.
[269] Considering all of these factors, and the principles set out in Whiten, I have determined that an appropriate award of punitive damages for each of Amar and Sunny to pay to Fund I is $250,000.[^30]
The Xtreme Labs Claim
[270] Originally, the plaintiffs claimed damages for the losses they suffered in selling their shares of Xtreme Labs to Chamath at an undervalued price. They also claimed damages for “lost opportunity” in respect of Hatch Labs due to the concealment of Xtreme Labs’ 13% equity interest in that company. Mr. Ferguson, the plaintiffs’ expert, calculated the plaintiffs’ damages as falling within the range of $42 million to $54 million. This amount is inclusive of their loss in respect of Hatch Labs, which Mr. Ferguson based on a value of USD$30 million.
[271] During closing submissions, the plaintiffs sought to amend their claim to elect a different remedy with respect to Hatch Labs. Instead of claiming damages for lost opportunity, the plaintiffs sought the equitable remedy of disgorgement of profits, in the amount of USD$30 million. The plaintiffs argued that this had always been a case about breach of fiduciary duty and they were not asserting a new cause of action or new material facts, just another remedy. The claim for disgorgement of profits was well within the amount that they claimed from the defendants from the outset.
[272] The defendants opposed the amendment. They argued that they had suffered prejudice that could not be compensated for by costs or an adjournment, as they would have conducted the trial differently if they had known about a claim for disgorgement of profits. After considering the defendants’ submissions, and for reasons delivered in court, I granted leave to the plaintiffs to amend their claim to seek disgorgement of profits for Hatch Labs. I held that there was no non-compensable prejudice, that this was simply another remedy, and that the defendants would not have been taken by surprise in any of the substantive allegations or amounts claimed. I held that most of the evidence with respect to profits would have been in the hands of the defendants or within their control to obtain same. I gave the defendants an opportunity to request an adjournment and to present further evidence and make additional submissions.
[273] On the return to court ten days later, the defendants advised that they maintained their position that they had suffered non-compensable prejudice and that leave to amend should not have been granted. They advised the court that they would not be seeking an adjournment and would not be tendering additional evidence or making further submissions on the Hatch Labs issue.
[274] I have granted the plaintiffs leave to amend to seek the equitable remedy of disgorgement of profits for Hatch Labs. I will therefore determine that issue based on the evidence at trial and the submissions made by counsel.
Damages – Xtreme Labs Sale excluding Hatch Labs
[275] The plaintiffs seek damages for their losses on the sale of Xtreme Labs, excluding losses in respect of Hatch Labs. Mr. Ferguson calculated the plaintiffs’ loss based on the understatement of Xtreme Labs’ value, which he said ranged from $31.88 million to $46.81 million (compared to the enterprise value of $18 million on which the plaintiffs’ sale to Chamath was based.)
[276] Mr. Cochran, for the defendants, valued Xtreme Labs at between $14.1 million and $17.6 million, below the $18 million. He therefore determined that the plaintiffs had not suffered any loss on their sale to Chamath.
[277] The plaintiffs acknowledge that Mr. Ferguson’s valuation analysis is problematic in several respects.[^31] They no longer rely on it. In particular, they accept that he did not normalize wage and benefit figures for 2009, which affected his EBITDA and EBITDA margin calculations and resulted in an inflated valuation.
[278] In closing submissions, the plaintiffs’ counsel proposed an alternative method of calculating damages. His method was to take the 2012 actual revenue number for Xtreme Labs ($17.2 million) and multiply it by 2.5 (the Pivotal multiplier from Chamath’s June 7 letter to his friends), for a purchase price of $43 million rather than $18 million. He proposed that the plaintiffs’ losses be calculated based on their pro rata share of that adjusted purchase price.
[279] The defendants argue that Mr. Cochran’s expert evidence should be accepted and that the plaintiffs’ counsel’s alternative method of calculating damages should be rejected. They submit that Mr. Cochran’s valuation proves that Xtreme Labs was never worth more than $18 million and that there is no evidence that any buyer was willing to pay a purchase price of more than that amount in August 2012.
[280] The defendants further note that both Mr. Ferguson and Mr. Cochran used the same valuation method, namely the discounted cash flow method, a primary component of which is EBITDA and EBITDA margin. Mr. Cochran testified that when the errors in Mr. Ferguson’s EBITDA’s calculations were corrected, it resolved 90% of the difference between the valuations of the two experts.
[281] The plaintiffs take issue with Mr. Cochran’s calculations. They submit that his calculations were made as of April 2012 (the date of the Seven Hills report) instead of the closing date, that he relied on the incomplete and inaccurate information provided to Seven Hills, and that he corroborated his analysis by looking at public companies with a different profile than a small company like Xtreme Labs.
[282] I accept Mr. Cochran’s evidence that his valuation would not have been significantly different if he had conducted his valuation as of the closing date. However, I attach less weight to his evidence as it was premised on much of the same information as was given to Seven Hills. I have found that information to be incomplete and inaccurate.
[283] Overall, I do not find either of the experts’ evidence to be of much assistance to me in calculating damages.
[284] As noted above, only Fund I, Ray and Imran have standing in this action as selling shareholders (not Ken as his shares were held by his family trust, which is not a party). I have found that Fund I, Ray and Imran sold their shares of Xtreme Labs based on the wrongful conduct of Chamath, Amar and Sunny.
[285] The evidence establishes that Fund I, Ray and Imran were prepared to sell their shares of Xtreme Labs based on a projected revenue figure of $12 million for FY 2012 multiplied by a 1.5 multiple. As I have found, the $12 million revenue figure was given by Amar and Sunny to the board and Seven Hills in breach of their fiduciary duties and was intended to facilitate the acquisition by Chamath (through El Investco) at a discounted price. The defendants knew that projected revenue was a critical component of the purchase price calculation. This method was incorporated from the beginning in Chamath’s March 20 offer when he gave the Pivotal transaction as a Comp – it was sold for “.75x current fiscal year projections.” I find that if Fund I, Ray and Imran had received more accurate revenue information about Xtreme Labs, they would have factored that information into their purchase price calculation.
[286] To put Fund I, Ray and Imran in the position that they would have been in but for the defendants’ wrongful conduct, I consider it appropriate to use the actual revenues of Xtreme Labs for FY 2012 – $17.2 million. Had Fund I, Ray and Imran been given accurate information about the financial position and prospects of the company, they would have had the opportunity to negotiate a sale to Chamath or another buyer based on this accurate information, or to continue to hold their shares. Using actual revenues of $17.2 million multiplied by a 1.5 multiple, the revised purchase price is $25.8 million, not $18 million.
[287] I am not prepared to use the 2.5 multiple proposed by the plaintiffs’ counsel. I do not have evidence from Pivotal to confirm Chamath’s statement that this was the multiple used in the EMC-Pivotal transaction. In any event, there is insufficient evidence for me to determine that 2.5 (or any multiple higher than the 1.5 figure used by the plaintiffs) would have been an appropriate multiple to use for Xtreme Labs in a sale transaction in August 2012.
[288] I therefore calculate the losses sustained by Fund I, Ray and Imran as follows. In Schedule 11 of Mr. Ferguson’s report, Fund I, Ray and Imran owned approximately 64.56% of the shares of Xtreme Labs sold on closing. All of the selling shareholders received $12 million cash based on the purchase price of $18 million, i.e. 66.67% of the purchase price. Fund I, Ray and Imran received 64.56% of the cash amount, i.e. $7.74 million. Using a $25.8 million purchase price and the same allocations, Fund I, Ray and Imran would receive 64.56% of $17.20 million ($25.8 million x 66.67%). That is $11.10 million instead of the $7.74 million they actually received. The difference is $3.36 million, representing the losses to Fund I, Ray and Imran.
[289] The purchase price of $18 million under the RSP Agreement was in U.S. dollars. In my view, it is appropriate that any adjustment to that purchase price also be calculated in U.S. dollars. The losses suffered by Fund I, Ray and Imran based on this adjusted purchase price are therefore USD$3.36 million.
[290] Chamath, El Investco, Amar, Sunny, Varma Holdco and Madra Holdco were all participants in the acquisition of Xtreme Labs that was based on the breaches of fiduciary and contractual duties. They all played a role in the conspiracy. In my view, they should be jointly and severally responsible for the USD$3.36 million in losses sustained by Fund I, Ray and Imran.
Disgorgement of Profits – Hatch Labs
[291] Fund I seeks disgorgement of the profits that the defendants received from the sale of Hatch Labs. It submits that Amar and Sunny concealed the existence of Xtreme Labs’ 13% equity interest in Hatch Labs (the “Hatch Labs Equity”) from Fund I in breach of their fiduciary duty and that Chamath knowingly assisted them in the breach of this duty. Fund I submits that it is entitled to a disgorgement remedy against Amar and Sunny as fiduciaries and against Chamath and El Investco for knowing assistance in breach of fiduciary duty.[^32]
[292] As noted above, the defendants take the position that the plaintiffs should not have been entitled to amend their statement of claim to seek disgorgement of profits. On the leave to amend motion, they argued that if leave was granted, only 41.82% of the profits from the sale of the Hatch Labs Equity should be disgorged, corresponding to Fund I’s percentage ownership of the shares of Xtreme Labs. They declined to tender more evidence or make further submissions after I permitted the amendment.
[293] The general principles governing fiduciary relief are set out by Hoy A.C.J.O. in Mady Development Corp. v. Rossetto, 2012 ONCA 31, 344 D.L.R. (4th) 706, at paras. 18-20:
• Fiduciary relief is equitable in nature.
• The remedies for breach of fiduciary duty are discretionary and are “dependent on all the facts before the court, and designed to address not only fairness between the parties, but also the public concern about the maintenance of the integrity of fiduciary relationships”, citing McBride Metal Fabricating Corp. v. H.W. Sales Company Inc. (2002), 2002 CanLII 41899 (ON CA), 59 O.R. (3d) 97 (C.A.), at para. 30.
• Fiduciary relief is aimed at two goals: restitution and deterrence. Restitution is aimed at returning a beneficiary to the position he would have been in but for the fiduciary’s breach. The goal of deterrence (or the prophylactic purpose) is to prevent fiduciaries from benefitting from their wrongdoing and maintain the integrity of the fiduciary relationship.
• A remedy for breach of fiduciary duty can be aimed at one or both of these purposes. The role each one plays is a function of the particular facts of the case.
• Deterrence is of particular importance where the beneficiary suffers no identifiable loss. In 3464920 Canada Inc. v. Strother, 2007 SCC 24, [2007] 2 S.C.R. 177, disgorgement of profits gained through a breach of fiduciary duty was ordered not for the purpose of making the beneficiary whole; but rather, to ensure that the fiduciary did not benefit from his wrongdoing, thereby deterring fiduciary faithlessness, and achieving the prophylactic goal.
[294] The only plaintiff claiming breach of fiduciary duty with respect to the Hatch Labs Equity is Fund I. Accordingly, only Fund I can seek disgorgement of profits as an equitable remedy for breach of fiduciary duty.
[295] At the time of the sale to Chamath (through El Investco), Fund I owned 41.82% of the shares of Xtreme Labs and therefore had a 41.82% indirect interest in the Hatch Labs Equity. Amar and Sunny, fiduciaries of Fund I, concealed the existence of the Hatch Labs Equity from Fund I at the time of the sale. Chamath/El Investco acquired the Fund I interest in the Hatch Labs Equity through his acquisition of Xtreme Labs, and Amar and Sunny benefitted through their increased shareholding in Xtreme Labs.
[296] One year later, Chamath, Amar and Sunny transferred the Hatch Labs Equity to their holding company, 239 Ontario. The shareholders of 239 Ontario were El Investco (50%), Amar and Sunny (25% each). Six months later, 239 Ontario sold the Hatch Labs Equity to IAC for USD$30 million.
[297] By concealing the existence of the Hatch Labs Equity, Amar and Sunny (working with Chamath/El Investco) deprived Fund I of the opportunity to take it into account on the sale of its shares of Xtreme Labs, to renegotiate any terms of sale or to decide not to sell its shares of Xtreme Labs at that time. Further, as a direct result of this concealment, Amar, Sunny and Chamath/El Investco were able to profit from Fund I’s interest in the Hatch Labs Equity. In my view, they should not be entitled to retain the profits attributable to their wrongdoing. A disgorgement order is required to serve a deterrent purpose in this case.
[298] In determining the extent of this equitable relief, however, I agree that the disgorgement order should only apply to the profits that correspond to Fund I’s 41.82% interest in the Hatch Labs Equity. Those are the only profits that flow from the breach of fiduciary duty. Concealment of the Hatch Labs Equity deprived Fund I from realizing 41.82% of the profits from the sale of the Hatch Labs Equity. Any disgorgement order beyond that would result in Fund I receiving profits to which it was not otherwise entitled.[^33]
[299] The evidence on the profits from the sale of the Hatch Labs Equity is as follows. Mr. Cochran attributed a value of $150,000 to $500,000 to the Hatch Labs Equity at the time of the Xtreme Labs sale. The investment of the defendants in acquiring the Hatch Labs Equity was therefore at most $500,000.[^34] In March 2014, 239 Ontario sold the Hatch Labs Equity to IAC for USD$30 million. According to Chamath, in April 2014, 50% of the funds from the $30 million sale (i.e. $15 million) were distributed to the investors in El Investco.[^35] Since Amar and Sunny owned the other 50% of the shares of 239 Ontario, they would have received the remaining 50% distribution ($15 million).
[300] On this evidence, I calculate the profits from the sale of the Hatch Labs Equity as $30 million from the sale of the Hatch Labs Equity, less the defendants’ investment of $500,000. There is no evidence that the defendants invested any additional funds in Hatch Labs prior to the sale to IAC. The profit is therefore $29.5 million ($30 million less $500,000).
[301] On the facts of this case, there is no issue in determining the accounting period for the disgorgement of profits: Strother, at paras. 88-95. The evidence is straightforward. All of the profits of the defendants with respect to the Hatch Labs Equity were generated from a single transaction, the sale to IAC, in March 2014. There is no earlier cut-off date to use for the accounting of profits.
[302] In my view, Fund I should be entitled to its share of the full increase in value of the Hatch Labs Equity. According to Chamath, the increase in value was due to the rise in popularity of Tinder during the 18 months following the sale of Xtreme Labs, “a lot of luck”. As a direct result of the defendants’ conduct, Fund I was precluded from realizing its share of that increase in value over the 18 month period.
[303] In exercising my discretion to award this equitable remedy, and based on the evidence before me, I order disgorgement of profits in the amount of $12.33 million, representing Fund I’s 41.82% interest in profits of $29.5 million. The defendants received these profits in U.S. dollars. I therefore consider it appropriate to also make the disgorgement award payable in U.S. dollars.
[304] Chamath, El Investco, Amar and Sunny acted in concert with one another on each step related to the acquisition and sale of the Hatch Labs Equity. Together they established 239 Ontario, which received and distributed the profits attributable to Fund I’s 41.82% interest in the Hatch Labs Equity. In my view, Chamath, El Investco, Amar and Sunny are all liable to account for Fund I’s share of these profits.
[305] I order that Chamath, El Investco, Amar and Sunny disgorge USD$12.33 million to Fund I, on a joint and several basis.
COUNTERCLAIM
[306] Amar, Sunny, Varma Holdco and Madra Holdco counterclaim against the plaintiffs for a wide variety of relief, including unpaid performance fees of $135,670, indemnification for expenses Amar and Sunny incurred as directors and officers of Fund I (including their legal fees in defending this action), a declaration that an amendment of the Fund I LP Agreement is invalid and a declaration that the plaintiffs were not entitled to pay the legal expenses of this litigation from Fund I’s funds.
[307] With respect to the performance fees, s. 8.2 of the Fund I LP Agreement provides that EVP GP is entitled to receive a performance fee of 20% of “realized profits” of Fund I, after expenses and the return of contributed capital. It is undisputed that all of the contributed capital was returned to the limited partners and that performance fees were paid to EVP GP in 2012 and 2013 and distributed to its shareholders. Varma Holdco and Madra Holdco claim that after the Shotgun was exercised, they never received any further performance fees, including any fees due to them from Fund I’s exit of Extreme Labs.
[308] EVP GP received payment of the holdback amount on the Xtreme Labs sale in August 2013. The Shotgun purchase of Varma Holdco and Madra Holdco’s shares closed on November 4, 2013. Varma Holdco and Madra Holdco received USD$1,450,291 for their shares of EVP GP. Up to that time, Amar and Sunny were managing directors of EVP GP and were responsible for calculating and distributing performance fees to its shareholders. However, Ray’s undisputed evidence is that Amar and Sunny did not raise the issue of any outstanding performance fees at the time of closing and accepted USD$1,450,291 for their shares of EVP GP. In my view, the plaintiffs had exercised the Shotgun and were buying the interests of Varma Holdco and Madra Holdco for the parties to go their separate ways. Amar and Sunny made no mention of the performance fees at the time, despite knowing that the Xtreme Labs holdback had been received three months before. In determining the parties’ intention on an objective basis, I find that they intended the share purchase price to be inclusive of all amounts owed to Varma Holdco and Madra Holdco with respect to EVP GP. No further performance fees are owed to them now.
[309] With respect to the claim for indemnification, I have found that Amar and Sunny engaged in misconduct, both in establishing the Annex Fund and in connection with the sale of Xtreme Labs. This misconduct precludes them from claiming indemnification for their expenses as directors and officers of EVP GP: see Unique Broadband, at para 77. Further, Article 6.6 of the Fund I LP Agreement specifically excludes bad faith and wilful misfeasance from the right to claim indemnity for expenses incurred as a director or officer of EVP GP.
[310] Amar and Sunny challenge the amendment to the Fund I LP Agreement in 2015. The amendment changed the calculation of the 20% performance fee due to EVP GP so that it is based on realized gains only, without any reduction for realized losses or other expenses. This had the effect of increasing the performance fees paid to EVP GP and reducing the amounts paid to limited partners (including Amar and Sunny). They argue that it shifted the burden of expenses (including the legal fees for this litigation) onto the limited partners. They further submit that this amendment was not properly approved in accordance with the Fund I LP Agreement.
[311] Ray’s uncontested evidence is in 2014, Fund I switched its external accountants in 2014. Fund I made this change, on the advice of its accountants, to bring its governing documents into conformity with Fund I’s actual accounting practices. There is no evidence that these actual accounting practices were any different than they were before the date of the Shotgun when Amar and Sunny oversaw the accounting.
[312] Article 6.3 of the Fund I LP Agreement permits EVP GP to make corrections to the document “to cure or correct any ambiguity or defective or inconsistent provision, clerical omission, mistake or manifest error contained herein”. Ray’s evidence is that while he did not need to do so, he sent the limited partners a letter describing the change as a matter of courtesy and 27 out of 31 limited partners approved the clarification. I find, on a balance of probabilities, that the amendment to the Fund I LP Agreement was made as a clarification to reflect the actual accounting practices of EVP GP. It was therefore a permitted change pursuant to Article 6.3. There is no basis for recalculating the performance fees paid to EVP GP.
[313] Finally, Amar and Sunny claim that the payment of legal fees for this action from Fund I funds was contrary to Article 6.8 of the Fund I LP Agreement. That section provides that EVP GP “will pay out of the funds of [Fund I] on hand, the costs or expenses of [Fund I] incurred in a commercially reasonable manner … such costs and expenses for which [EVP GP] is to be reimbursed include … other costs and expenses, including legal and audit fees … incurred in connection with [Fund I]’s business or the evaluation of investment opportunities by [Fund I]”.
[314] There is no basis to find that the legal fees are not being incurred in a commercially reasonable manner. In any event, that is a matter that can be addressed at the costs stage of this trial. With respect to the submission that these fees are not incurred in connection with Fund I’s business, I disagree. These legal fees are being incurred in connection with Fund I’s business of protecting its limited partners’ investments in the fund and in its portfolio companies.
CONCLUSION
[315] For the above reasons, I have concluded that the defendants engaged in unlawful conduct through their breaches of fiduciary and contractual duties, knowing assistance in breach of fiduciary duty, inducing breach of contract, and conspiracy.
[316] I make the following orders:
(a) In respect of the Annex Fund Claim, each of Amar and Sunny shall pay punitive damages to Fund I in the amount of $250,000.
(b) In respect of the Xtreme Labs Claim, Chamath, El Investco, Amar, Sunny, Varma Holdco and Madra Holdco, jointly and severally, shall pay damages in the amount of USD$3.36 million to Fund I, Ray and Imran.
(c) In respect of the Xtreme Labs Claim, Chamath, El Investco, Amar and Sunny, jointly and severally, shall pay in disgorgement of profits the amount of USD$12.33 million to Fund I.
[317] The orders in subparagraphs (b) and (c) are in U.S. dollars. The parties may make written submissions as to the exchange rate that should apply to each order pursuant to s. 121 of the Courts of Justice Act, R.S.O. 1990, c. C.43. The plaintiffs’ submissions shall be delivered within 21 days and the defendants’ within 21 days thereafter.
[318] If the parties are unable to agree on costs, I will receive written submissions (no longer than ten pages double spaced, exclusive of bill of costs). The submissions shall be delivered in the same order and on the same schedule as those with respect to the applicable exchange rate.
Conway J.
Released: May 14, 2019
CORRECTION NOTICE
Corrected decision: The text of the original judgment was corrected on May 16, 2019, and the description of the correction is appended.
May 16, 2019: Larissa Fulop’s name was added on the first page as counsel for the Defendants Chamath Palihapitiya and El Investco 1 Inc.
COURT FILE NO.: CV-14-10635-00CL
DATE: 20190514
ONTARIO
SUPERIOR COURT OF JUSTICE (COMMERCIAL LIST)
BETWEEN:
EXTREME VENTURE PARTNERS FUND I LP, EVP GP INC., RAVIDER KUMAR SHARMA, IMRAN BASHIR, and KENNETH TESLIA
Plaintiffs/Defendants by Counterclaim
– and –
AMAR VARMA, SUNDEEP MADRA, VARMA HOLDCO INC., MADRA HOLDCO INC., CHAMATH PALIHAPITIYA, EL INVESTCO 1 INC., EXTREME VENTURE PARTNERS ANNEX FUND I LP, EVP GP ANNEX FUND I INC., CASSELS BROCK & BLACKWELL LLP, and SEVEN HILLS GROUP LLC
Defendants/Plaintiffs by Counterclaim
REASONS FOR JUDGMENT
Conway J.
Released: May 14, 2019
[^1]: The overall financing commitment from Northleaf was to be $20 million, $5 million of which was to be invested in the Annex Fund.
[^2]: According to Ray, the Facebook offer valued the company at $50 million, with $45 million to employees and only $5 million going to the shareholders. That was a non-starter for the board.
[^3]: The evidence is that Xtreme Labs acquired an equity interest in these companies in exchange for services provided and a cash investment.
[^4]: There was no evidence from Pivotal at the trial on what the multiplier was or on any other matter. I am not relying on what Ray said Rob Mee told him for the truth of its contents. The evidence at trial is only what Ray said he understood was a fair multiple from his conversation with Mr. Mee.
[^5]: Sunny’s evidence is that he knew of Seven Hills from a cold call he received from them in late 2011.
[^6]: Amar also sent a projection of $14 million for calendar year 2012 to Seven Hills. His evidence is that this number was consistent with the $12 million FY 2012 projection but forecasted some growth in the final calendar quarter of 2012. I note that Seven Hills used a number of $12.184 million for projected calendar year 2012. Its report states that all numbers were provided by Xtreme Labs management.
[^7]: Before making the offer, Imran and Ken asked Mr. Ahmed, the company’s bookkeeper, for the 2011 actual revenues for Xtreme Labs.
[^8]: While Amar testified that this money came from their own funds, the contribution was financed by having Xtreme Labs pay $2 million in Scientific Research and Experimental Development program credits to the selling shareholders 90 days after closing. This payment was set forth in s. 2.3 of the Redemption and Share Purchase Agreement. It does not identify this as a contribution by Amar and Sunny towards the purchase price.
[^9]: Calendar year 2012 revenues were $21 million, 50% higher than the calendar year projection of $14 million Amar gave to Seven Hills.
[^10]: They also testified about a product, XL Studio, that was developed after closing and that was one of the reasons that Pivotal wanted to acquire Xtreme Labs after closing. As noted, there was no evidence from Pivotal at trial on this or any other issue. At trial, Chamath did not dispute his statements on discovery that XL Studio was a “cockamamie mobile gateway product” that “didn’t work”.
[^11]: While I find that Amar and Sunny agreed to cause Fund I to guarantee the expenses of the Annex Fund, the evidence is insufficient for me to find that Fund I actually paid any expenses of the Annex Fund.
[^12]: Amar’s email to Chamath on July 17 explicitly states that they conducted weekly finance reviews. Mr. Ahmed, the company’s bookkeeper, testified that in general monthly revenues were known within one week of month end.
[^13]: The monthly revenues for October, November and December 2011 were $1.3 million, $1.2 million and $1.4 million, respectively.
[^14]: Chamath’s reference to buying the company for $16 million is also accurate – it is the $18 million purchase price less the $2 million he required Amar and Sunny to invest. The reference to $35-40 million for the next year is equal to 100% growth over FY 2012 fiscal year revenues of approximately $17.2 million.
[^15]: The plaintiffs advised at the commencement of trial that their claims against the defendant Cassels Brock & Blackwell LLP had been resolved and that the trial was not proceeding with respect to the claims against Seven Hills Group LLC.
[^16]: The defendants focused on the plaintiffs’ conduct in part to support their argument that Amar and Sunny did not owe an ad hoc fiduciary duty to the individual plaintiffs. However, the plaintiffs’ counsel confirmed at the hearing that the individual plaintiffs are not asserting an ad hoc claim for breach of fiduciary duty. Only Fund I/EVP GP is asserting a breach of fiduciary duty claim.
[^17]: Ken highlighted this in an email exchange with Amar in November 2012 when he stated that the brand “is a joint asset. Not yours not mine but the partners of EVP” and that one of the two camps should make a shotgun proposal to take over the brand. Amar and Sunny had been operating the Annex Fund under the EVP brand for almost a year at that point.
[^18]: The limited partners were entitled to receive limited partner updates that provided some basic information about Fund I’s portfolio companies. While s. 10 of the Limited Partnerships Act, R.S.O. 1990, c. L.16 entitles limited partners to receive true and full information concerning the limited partnership, I am not persuaded that they were entitled to receive the detailed information about each portfolio company. Hello Warrior’s minimal shareholding in Xtreme Labs did not entitle Chamath to receive this information under the XL Shareholders’ Agreement nor would it have given Hello Warrior the right to receive it under s. 145 of the Business Corporations Act.
[^19]: Indeed, Chamath admitted that while it was Amar and Sunny’s decision whether to provide information, he would probably have scuttled the deal if he did not receive it.
[^20]: The agreement uses the date January 31, 2011. All parties agreed that this is a typographical error and that the date should be January 31, 2012.
[^21]: Since all of these contracts were with existing customers of Xtreme Labs, they do not fall within the exception at the end of s. 3.2(d) of agreements with third parties introduced to the Founders, the Corporation and each of its Subsidiaries by the Purchaser.
[^22]: According to Amar, the Facebook contract was $3 million, Thomson Reuters was $1 million and the remaining $1 million came from the NBA and NFL contracts.
[^23]: Given the amount of work that would have had to be done on these contracts in order to bill them by September 30, 2012, there is no basis to conclude that they would have been entered into after closing, six weeks before the fiscal year end.
[^24]: While Mr. Cochran testified that a $3 million contract would not have been material (as the valuation of a company is based on EBITDA), it is clear that the plaintiffs were relying on the revenue projections in determining the purchase price for their shares.
[^25]: In the plaintiffs’ Amended Fresh as Amended Statement of Claim, they allege wrongdoing on the part of Chamath and El Investco with respect to Tinder. They plead that Chamath and El Investco acquired Xtreme Labs when they knew that Amar and Sunny had concealed the existence of Tinder – see, for example, paras. 53, 60, 99. This was part of the alleged conspiracy.
[^26]: The wording “over the course of the last year” suggests that the conspiracy started well before the February 1, 2012 email, as early as fall 2011.
[^27]: The plaintiffs confirmed at trial that they were not seeking disgorgement of profits with respect to the Annex Fund Claim.
[^28]: Mr. May was not qualified as an expert on reputational harm and I have disregarded his evidence on that issue. I note, in any event, that he did not quantify the reputational damage allegedly sustained by the plaintiffs.
[^29]: The plaintiffs argue that they should not be penalized for the fact that the Annex Fund shut down early. I am unable to make a finding as to why the Annex Fund shut down when it did as I have no evidence from Northleaf on this issue. I cannot make any damages award based on the timing of the Annex Fund shutdown.
[^30]: I am satisfied that this amount falls within an acceptable range established by case law. The punitive damages in Whiten were $1 million. In Ward v. Manufacturers Life Insurance Co., 2007 ONCA 881, 288 D.L.R. (4th) 733, the Court of Appeal upheld a punitive damages award of $250,000 for breach of fiduciary duty. See also Elekta Ltd. v. Rodkin, 2012 ONSC 2062, in which D. M. Brown J. (as he then was) awarded $200,000 in punitive damages, in addition to compensatory damages.
[^31]: The plaintiffs acknowledge that there were three errors. Mr. Ferguson did not normalize wage and benefit figures for 2009, which had an impact on his EBITDA and EBITDA margin calculations. He used April 2012 as the initial valuation date but then changed the valuation date to August 2012 without changing the period adjustment figure, which would have significantly lowered the valuation. He also did not properly allocate the purchase price that was paid to the plaintiffs in calculating their losses.
[^32]: A person who knowingly assists another in breach of fiduciary duty is liable to account for profits: see Enbridge Gas Distribution Inc. v. Marinaccio, 2011 ONSC 2313, at para 22, affirmed, 2012 ONCA 650, 355 D.L.R. (4th) 333, leave to appeal refused (2012), 320 O.A.C. 396.
[^33]: This approach is consistent with that taken by the Court of Appeal in Olson v. Gullo (1994), 1994 CanLII 1268 (ON CA), 17 O.R. (3d) 790 (C.A.) and Rochwerg v. Truster (2002), 2002 CanLII 41715 (ON CA), 58 O.R. (3d) 687 (C.A.)
[^34]: When 239 Ontario acquired the shares of Glooko, Extreme Startups and Hatch Labs in September 2013 prior to the sale to Pivotal, it paid Xtreme Labs $977,000. Amar allocated $100,000 of that amount to Hatch Labs.
[^35]: Chamath testified that of this amount his family trust received just over $10 million, net of taxes and expenses.