COURT FILE NO.: CV-21-00665909-00CL DATE: 2022-03-08 SUPERIOR COURT OF JUSTICE – ONTARIO (COMMERCIAL LIST)

RE: FSD PHARMA INC., Applicant AND: RAZA BOKHARI, JAMES DATIN, ROBERT CIARUFFOLI, STEPHEN BUYER, GERALD GOLDBERG, HAYWOOD SECURITIES INC., HAYWOOD SECURITIES (US) INC. and COMPUTERSHARE INVESTOR SERVICES INC., Respondents

BEFORE: Koehnen J.

COUNSEL: R. Seumas M. Woods, Doug McLeod and Natalie Cammarasana, for the Applicant Luis Sarabia and Andrew Carlson, for the Respondent, Raza Bokhari Tudor Carsten and Breanna Needham, for the Respondent, Computershare Investor Services Inc.

HEARD: December 20, 2021

ENDORSEMENT

[1] Raza Bokhari was at all material times to this application, the Chief Executive Officer and Executive Co-Chair of the Board of Directors of the applicant, FSD Pharma Inc. On February 10, 2021, FSD issued Bokhari 1,173,709 Class B shares with a value of approximately $2.5 million. The shares were issued to him in lieu of monetary compensation for his services for the 2021 calendar year.

[2] After a proxy contest between shareholders, Bokhari was removed from the Board and terminated as CEO. The new board also cancelled the vast majority of the shares issued to Bokhari on the basis that they were issued in violation of s. 23 of the Ontario Business Corporations Act (the “OBCA”) [1] which prohibits corporations from issuing shares for future consideration. The board allowed Bokhari to retain 41/365ths of the share issuance on the theory that he had provided service for 41 days of calendar 2021 before the shares were issued on February 10.

[3] FSD applies to validate the share cancellation. Bokhari takes the position that if FSD has any complaint about the share issuance, it must be pursued by way of an action under s. 130 of the OBCA against the directors who approved the share issuance. Section 130 permits claims against directors specifically for issuing shares in violation of s. 23.

[4] At the end of oral argument, I stated that I would allow Bokhari to retain 208/365ths of the shares issued because his employment was not terminated until July 27, 2021, that is to say on the 208th day of 2021. This endorsement contains the reasons for that ruling.

[5] The ruling is without prejudice to FSD pursuing whatever claims it wishes against Bokhari and is without prejudice to Bokhari pursuing whatever claims he wishes against FSD, (including for wrongful dismissal) other than claims for the shares being cancelled as a result of these reasons. For greater certainty however, FSD shall not be entitled to set off any claim it has against Bokhari against the shares that Bokhari is being allowed to retain unless and until FSD has an enforceable judgment against him.

Factual Background

[6] FSD is a publicly traded company whose shares trade on the Canadian Stock Exchange and on the NASDAQ Exchange under the symbol “HUGE”.

[7] Differences of opinion emerged among the directors and shareholders of FSD in December 2020. On January 4, 2021, two directors and a number of shareholders requisitioned a shareholders’ meeting to elect a new board. On January 21, 2021, the existing board scheduled the requisitioned meeting for June 29.

[8] In response, the dissenting directors and shareholders announced their intention to hold a meeting of FSD shareholders on March 31, 2021, and to bring an application to this Court for an order confirming the March 31, 2021, meeting date or scheduling a meeting on some other date earlier than June 29, 2021.

[9] At a directors meeting on February 10, 2021, the existing board approved Bokhari’s compensation for 2021.

[10] Bokhari’s employment contract provides for compensation of $1.00 cash per year plus such share grants as the board may issue based on Bokhari’s prior and anticipated performance. Compensation was to be renegotiated annually with an attempt to have the new annual compensation in place by March 31 of each year.

[11] At the meeting on February 10, the Board granted Bokhari 1,173,709 Class B Securities as compensation for his services as Co-Chair and CEO of FSD for the calendar year 2021. Those shares had a monetary equivalent of approximately $2.5 million.

[12] On March 4, 2021, McEwen J. heard the application to set the date for the requisitioned shareholders meeting. He ordered the meeting to be held on May 14, 2021, and ordered that it be presided over by a chair who was independent of both shareholder/director groups. In addition, McEwen J. ordered that Bokhari not be permitted to vote any of the class B shares issued to him in February.

[13] The meeting proceeded as ordered on May 14, 2021 and resulted in the replacement of the board. Bokhari was not elected to the new board. The new board met immediately after the shareholders meeting, appointed a special committee to investigate Bokhari’s conduct and placed Bokhari on leave pending the result of that investigation.

[14] On June 1, 2021, the new board unanimously passed a resolution that allowed Bokhari to keep 41/365ths of the shares that had been issued to him on February 10, 2021, but cancelled the remainder. Bokhari was allowed to retain 41/365ths of the shares on the theory that when those shares were issued on February 10, Bokhari had provided 41 of 365 days of service for calendar 2021 and had therefore provided consideration for those shares. As of February 10, he had not, however, provided consideration for the balance of the shares issued to him. The new board took the position that these remaining shares were issued contrary to s. 23 of the OBCA which prohibits issuing shares for future consideration and cancelled them.

[15] Bokhari takes the position that he is entitled to retain all of the shares issued to him and that, in any event, FSD’s complaint is precluded by cause of action estoppel because it ought to have raised the validity of the share issuance during the hearing before McEwen J. but failed to do so.

A. Consequences of the Share Issue

[16] Section 23 (3) of the OBCA provides:

23 (3) Fully-paid shares – A share shall not be issued until the consideration for the share is fully paid in money or in property or past service that is not less in value than the fair equivalent of the money that the corporation would have received if the share had been issued for money. (emphasis added)

[17] The record is clear in my view that the shares were issued to Bokhari as compensation for a full year of service rather than for the 41 days that had elapsed by the time of issue.

[18] The minutes of meetings speak of compensation “for the year 2021.” The cash equivalent of the shares that Bokhari received on February 10, 2021, was equal to what he received in shares for the entire calendar year of 2020. Directors of FSD were compensated in a similar manner. [2] The management discussion and analysis dated as of May 14, 2020, noted that as of March 31, 2020, directors had received their full compensation for the 2020 fiscal year in advance, through the issuance of class B shares. The email from FSD counsel dated July 20, 2020, issued Bokhari Class B shares for 2020 for “services rendered and to be rendered in 2020.”

[19] The issue then is what is the status of shares that were issued for future consideration. Are they void from the outset or does their status depend on the circumstances of the individual case?

[20] The strongest case suggesting that shares issued for future consideration should be void ab initio is Javelin International Ltd. (Receiver of) v Hillier [3], in which Gomery J. relied on Professor Bruce Welling’s text Corporate Law in Canada, to hold that the issuance of shares without full consideration having already paid renders the issuance a nullity. [4]

[21] It seems fairly clear however that subsequent case law has taken a more flexible approach. [5] Both sides here agree that shares issued for inadequate consideration may be flawed but are not a nullity. Their specific status and the appropriate remedy depend on the circumstances of the case.

[22] Bokhari submits that, not only are the shares not a nullity but that he should be permitted to retain all the shares that were issued because of s. 130(1) of the OBCA. That section provides:

130(1) Directors of a corporation who vote for or consent to a resolution authorizing the issue of a share for a consideration other than money contrary to section 23 are jointly and severally liable to the corporation to make good any amount by which the consideration received is less than the fair equivalent of the money that the corporation would have received if the share had been issued for money on the date of the resolution.

[23] The presence of this remedy provides further force to the argument that the issuance of shares contrary to s. 23 does not make them a nullity. The presence of a compensatory remedy for breach of s. 23 presupposes that the shares are valid in the hands of the recipient. [6]

[24] I would not, however, go as far as Bokhari would like me to and hold that s. 130 has the effect of allowing those who received shares for future consideration to retain them regardless of the circumstances. Section 130 is not aimed solely at holding directors liable for issuing shares for future consideration but is aimed at all breaches of s. 23, including issuing shares for past but inadequate consideration. Moreover, I have not been directed to any authority which suggests that s. 130 constitutes an exclusive remedy for all breaches of s. 23.

[25] I find the reasoning of the Alberta Court of Appeal in Pearson Finance Group Ltd. v. Takla Star Resources Ltd. [7] to provide a more attractive solution than the options of nullity ab initio or retention as of right. In that case the court noted that nowhere did the Alberta Business Corporations Act at issue there state clearly or by necessary implication that shares issued in breach of any of its sections amounted to a nullity. The court noted that many other cases have interpreted a variety of other statutes in ways that do not equate prohibited conduct with nullity. [8]

[26] The court in Pearson discussed a number of factors in paragraphs 11-20 that I distil into the following non-exclusive considerations:

(i) Was the breach of the provision serious or trivial? (ii) Can the breach can be corrected? (iii) Is the consequence of nullity excessively harsh or unjust? (iv) What prejudice do different solutions impose on the parties? (v) Can the mischief that the statute seeks to avoid be addressed short of nullity?

[27] In my view, the foregoing considerations provide a clear and equitable solution to the problem at hand. That is to allow Bokhari to retain that portion of the share issuance that reflects his days of actual employment by FSD in 2021 and not merely those that reflect the 41 days of service that preceded the share issue.

[28] Bokhari continued to be employed by FSD until July 27, 2021. Although he was placed on leave on May 14, the letter advising him of this stated that he was being “placed on a temporary paid leave” pending the conclusion of an investigation into his activities.

[29] His employment was not terminated until July 27, 2021, or 208 days into the calendar year. As a result, I would allow him to retain 208/365ths of the shares and allow FSD to cancel 157/365ths of the shares issued. Translated into percentages and hard numbers, I would allow Bokhari to retain 56.986% of the shares or 668,850 shares and would allow FSD to cancel the remaining 43.014% or 504,859 shares.

[30] This approach is consistent with the language of the statute and the intentions of the parties.

[31] The parties clearly intended to compensate Bokhari for his role as CEO and Co-Chair by paying him in shares of FSD. His employment contract called for payment of $1.00 annually plus such other compensation as the board deemed fit. Paying Bokhari in shares benefitted the corporation in its infancy because it conserved cash for other business purposes. The purpose of the arrangement was not to have Bokhari work without compensation. Bokhari delivered 208 days of consideration and should be compensated for that as the parties had intended.

[32] Had the resolution of February 10 divided the share issuance into 12 monthly instalments and provided Bokhari with 1/12 of the shares at the end of each month, it would have been unassailable because all shares would have been issued for past consideration. The remedy I am awarding essentially does the same thing.

[33] Bokhari may argue that had FSD wanted to issue 1/12 of the shares at the end of each month it could have done so. It did not, as a result of which he should be allowed the benefit of the bargain that was struck. In my view, however, that bargain violated s. 23. Allowing FSD to cancel the balance of the shares is consistent with s. 23 by preventing the issuance of shares for which no consideration has been received.

[34] I am also mindful that the full year’s allocation of shares on February 10 was made after a proxy contest to unseat Bokhari and the Board had already begun. It would not, in my view, be appropriate to allow Bokhari the potential windfall of being paid up front when his tenure at FSD was already under attack and was ultimately terminated.

[35] Bokhari further submits that in Mennillo v. Intramodal Inc. [9], the Supreme Court of Canada held that corporations could cancel shares in only very limited circumstances. I read Mennillo more restrictively than that. All that the Supreme Court of Canada stated at paragraph 63 of Mennillo was that a corporation could not retroactively cancel shares based on an alleged oral agreement when that agreement is contested.

B. Cause of Action Estoppel

[36] Cause of action estoppel is a branch of the doctrine of res judicata that prevents “litigation by instalment.” It is designed to prevent litigants from bringing claims that could and should have been raised, in an earlier proceeding. [10] The essence of cause of action estoppel was summarized by Sharpe J. as he then was, Las Vegas Strip Ltd. v. Toronto (City) [11], as follows:

Does the fact that Las Vegas now relies upon a different legal theory remove the present claim from the reach of the old? In my view it does not. The authorities establish that a litigant cannot establish a new and fresh cause of action by advancing a new legal theory in support of a claim based upon essentially the same facts. As was stated by the Privy Council in Hoystead v. Taxation Commissioner, (a passage quoted with approval by the Supreme Court of Canada in Maynard v. Maynard, per Cartwright J.):

Parties are not permitted to begin fresh litigations because of new views they may entertain of the law of the case, or new versions which they present as to what should be proper apprehension by the Court of the legal result either of the construction of the documents or the weight of certain circumstances.

If this were permitted, litigation would have no end, except when legal ingenuity is exhausted. It is a principle of law that this cannot be permitted, and there is abundant authority reiterating that principle. [12] (Citations omitted)

[37] Bokhari submits that the cancellation of the shares should have been raised in the application before McEwen J.

[38] There is a difference, however, between being obliged to raise an issue during the course of a lengthier proceeding on the merits and a real-time litigation issue of the sort that McEwen J. had before him. In Las Vegas the first action took 2 years to get to trial. The hearing before McEwen J. occurred exactly one month after the notice of application was issued. A lengthier proceeding gives the parties more time to consider evolving issues through pleadings, documentary production, examinations for discovery, or in the case of an application, through the exchange of affidavits and cross-examinations in a period longer than 4 weeks. This is not to say that a proceeding that took 4 weeks from start to finish is not capable of being subject to cause of action estoppel, that will always depend on the full circumstances of the case.

[39] The application before McEwen J. was not, however, intended to resolve all issues between the parties but to resolve only the date of the shareholders’ meeting. When the matter came before McEwen J., the court had only two hours of hearing time available. The application before me took three hours and that was after I had advised FSD that I needed to hear from it on only why a pro rata cancellation would not be appropriate. McEwen J. recognized the urgency of the hearing before him and the imperfection inherent in that process by stating in his endorsement:

Last, given the rushed nature of the hearing and the release of these reasons, the parties, as noted, can return for further directions or orders to clarify issues or to deal with the implementation of my order.”

[40] This implicitly recognizes that the hearing before him did not deal with all issues between the parties but dealt solely with the issue of which of the two meetings should proceed.

Costs

[41] Each side submits that it was successful in the proceeding and should be awarded its costs. FSD claims $106,767.52 on a partial indemnity scale including disbursements and HST. Bokhari claims an all-inclusive amount of $220,688.94.

[42] In addition, Bokhari submits that, although he did not make a formal written settlement offer, the respondents, including himself, “sent an extremely strong signal” that they were willing to settle on the terms that I ultimately ordered. In making this submission Bokhari relies on a sentence in the affidavit of the respondent Stephen Buyer to the effect that:

FSD could reissue a number of Class B Shares to each Respondent Director so that each Respondent Director would receive a number of shares proportionate to the number of days in 2021 that he served as a Director of FSD (or in Dr. Bokhari’s case as CEO of FSD).

[43] In addition, Bokhari submits that his counsel engaged in settlement discussions with FSD counsel in which he made an offer to settle on the basis that I ultimately ordered.

[44] I do not accept that Bokhari made a settlement offer. The statement in the affidavit that Bokhari refers to is a statement in an affidavit of another respondent who was represented by separate counsel. That respondent and that counsel ultimately settled with FSD. Bokhari and FSD did not settle. I am also not prepared to entertain submissions about alleged settlement offers made orally in conversations with counsel; especially not here when counsel disagree about what was said. Both parties were represented by sophisticated counsel. Had Bokhari wanted to make a settlement offer based on the sentence quoted in paragraph 42 above, he could easily have done so. Similarly, had he wanted to extend a settlement offer based on the content of discussions between counsel, he could have done that as well. He did not. I can only assume that was a considered choice.

[45] Success has been almost equally divided. When I factor out the 41 days worth of shares that FSD did not try to cancel (131,842), that left 1,041,867 shares in dispute. My disposition gives Bokhari 536,978.25 of those shares and gives FSD 504,888.75.

[46] Although, strictly speaking, Bokhari, “won” more than FSD did, the difference is so small that it does not, in my view, merit a cost award. To the extent that difference does, in principle, merit a cost award, I would still decline to award costs. The matter was subject to several case conferences at the request of Bokhari that unnecessarily increased legal fees for all parties. Those were ultimately tactical efforts by Bokhari, none of which was successful. In the circumstances I decline to order costs and will require each party to bear its own costs.

Conclusion

[47] For the reasons set out above, I order that FSD be free to cancel 504,888.75 of the shares issued to Bokhari on February 10, 2021 and that Bokhari be entitled to retain the balance of the shares issued to him on February 10, 2021. Each party will bear its own costs.

Koehnen J. Date: 2022-03-08

Footnotes

[1] RSO 1990, c B. 16 [2] The application initially also addressed share issuances to other directors of FSD. Those directors have resolved that issue with FSD. As a result, by the time the matter reached the oral hearing, the only remaining issue was the validity of the shares issued to Bokhari [3] [1988] R.J.Q. 1846, [1988] Q.J. No. 928, 40 B.L.R. 249 (Que Sup Ct) [4] Javelin at paras. 21 to 25 citing Welling, Corporate Law in Canada, 1st ed (Toronto: Butterworths, 1984) at p. 683. [5] See for example Dunham v Apollo Tours Ltd., Pearson Finance Group Ltd. v Takla Star Resources Ltd. 2002 ABCA 84; and Robert Mandel et al v 1909975 Ontario Inc. 2020 ONSC 5343 aff’d at 2021 ONCA 844. [6] Davidson v. Davidson Manufacturing Co. (1977) Ltd., 1978 CarswellBC 746 (Sup. Ct.), at paras. 21-22, [1978] B.C.J. No. 60 [7] 2002 ABCA 84 [8] Pearson and para. 9. [9] Mennillo v. Intramodal Inc., 2016 SCC 51 [10] See for example: Henderson v. Henderson, (1843) 67 E.R. 313 (U.K. Ch.) at p. 319, Reddy v. Oshawa Flying Club, 1992 CarswellOnt 349 (Gen. Div.) at paras. 7-8, [1992] O.J. No. 1337. [11] Las Vegas Strip Ltd. v. Toronto (City); aff’d at [12] Las Vegas at para. 24