Court File and Parties

COURT FILE NO.: CV-22-00645328 DATE: 20220411 SUPERIOR COURT OF JUSTICE - ONTARIO

RE: Saeed Darvish-Kazem, Applicant – AND – Pazkaz Enterprises Inc., Rave Inc., Michael Pazaratz, and Lynda Cooper, Respondents

BEFORE: Justice E.M. Morgan

COUNSEL: Danielle Muise, for the Applicant John Mather and Jadeney Wong, for the Respondents

HEARD: February 22, 2022

SHAREHOLDER OPPRESSION APPLICATION

[1] The Respondent, Pazkaz Enterprises Inc. (“Pazkaz”), is a holding company that owns roughly 40% of the shares of a start-up software company, the Respondent, Rave Inc. (“Rave”). The Applicant (“Darvish-Kazem”), who is a 40% shareholder of Pazkaz, claims that his interest as a shareholder has been unfairly prejudiced and/or disregarded by the way in which Pazkaz and Rave have recruited new investment. He seeks a variety of remedies under section 248 of the Ontario Business Corporations Act, RSO 1990, c. B.16 (“OBCA”).

[2] The balance of the shares of Pazkaz are owned by the Respondent, Michael Pazaratz (“Pazaratz”), and the balance of the shares of Rave are owned by a combination of Pazaratz, several Rave employees, and Pazaratz’s mother, the Respondent Lynda Cooper (“Cooper”). It is Darvish-Kazem’s contention that shares issued to Pazaratz and to Cooper have improperly diluted his own shareholding and have resulted in unfair and oppressive treatment of him as an investor in this start-up business.

[3] The business, although promising, has yet to turn a profit. Darvish-Kazem’s demands include having audited statements and a full accounting produced for Pazkaz and Rave. He also demands that he be bought out of the business, have his equity converted to shareholder loans and be repaid, that Pazaratz and Cooper be removed as officers and directors of either or both of Pazkaz and Rave, and, if the financial remedies he seeks are not possible, a forced sale or winding up of the entire enterprise.

I. Origins of the business

[4] Upon founding Rave, the two initial investors, Pazaratz and Darvish-Kazem, agreed to create a holding company, Pazkaz, as their investment vehicle. Darvish-Kazem and Pazaratz initially agreed to fund the business themselves, with a long-term goal of securing outside investors. They were initially each 50% shareholders of Pazkaz.

[5] Subsequently, in September 2015, at Darvish-Kazem’s request, the respective ownership and financial contributions changed to 60% for Pazaratz and 40% for Darvish-Kazem. No shareholder agreement for Pazkaz has ever been signed between Darvish-Kazem and Pazaratz. They did, however, sign a Loan Resolution coincident with the 60-40 restructuring of the holding company. The resolution memorialized that the parties’ respective contributions to Pazkaz were $960,000 for Mr. Pazaratz and $640,000 for Mr. Darvish-Kazem, and that Pazkaz would carry these contributions on its books as shareholder loans. It also provided that no further shares of Pazkaz would be issued until the shareholder loans were repaid in full.

[6] There was no mention in this documentation of Rave. The Pazkaz Loan Resolution does not place any restrictions on Rave’s distribution of its shares. Indeed, while such a restriction might make sense for a holding company like Pazkaz, it would make no business sense at all for an operating company like Rave in need of ongoing financial infusions to be successful.

[7] Likewise, there is no resolution or other type of agreement prepared for Rave dealing with Pazkaz’s contributions to Rave or converting those contributions to shareholder loans. Although Darvish-Kazem now contends that this is what should have been done, there is no documentation to that effect and, as Secretary and Treasurer of Pazkaz, Darvish-Kazem took no steps to convert Pazkaz’s investment into debt.

[8] In mid-2016, Darvish-Kazem who, like Pazaratz, is a physician by training, resumed the full-time practice of medicine and advised Pazaratz that he no longer was interested in funding Pazkaz going forward. This development coincided with a series of personal and financial disputes between the two individuals.

[9] By February 21, 2017, Rave was on the brink of bankruptcy. Pazaratz contributed $150,000 to Pazkaz to allow Rave to continue operations. At the same time, Pazaratz sought to have Darvish-Kazem contribute his corresponding 40% (or $100,000). Darvish-Kazem refused to do so, and had his lawyer send Pazaratz a letter stating that Pazaratz’s own contribution to Rave (via Pazkaz) was “improper”. Darvish-Kazem’s specific complaint was that Pazaratz had not had this necessary infusion of cash approved by the Pazkaz board (composed of Pazaratz and Darvish-Kazem). In other words, Darvish-Kazem sought a veto over the lifeline being cast to their mutual business venture despite not contributing any funds to that lifeline.

[10] In March 2017, with Darvish-Kazem having ceased participating in any managerial responsibilities for the business, Pazaratz voted to remove Mr. Darvish-Kazem as a director and officer of Pazkaz and Rave. After that, neither Pazaratz nor Darvish-Kazem contributed any further funds to Pazkaz. The parties agree that the total funds invested in Pazkaz prior to their falling out is $1,058,103.05 (40%) for Darviah-Kazem and $1,582,791.61 (60%) for Pazaratz. In turn, Pazkaz’s contribution to Rave comes to a total of $2,640,894.66.

[11] Subsequent to Darvish-Kazem’s departure, Rave continued to require an infusion of fresh funds in order to stay alive. Pazaratz was unable to raise money from outside sources, and so turned to family for help. Pazaratz’ mother, Lynda Cooper, agreed to make an investment in Rave so that it could continue in operation. To date, she has invested $1,621,000. Pazaratz gave Darvish-Kazem advanced notice of this investment by Cooper in April 2017, subsequent to which, in September 2017, Rave first issued shares to Cooper.

[12] In his correspondence of April 2017, Pazaratz advised Darvish-Kazem that Cooper was prepared to pay $30,000 a share based on a $3 million valuation of Rave. Pazaratz also offered to sell shares to Darvish-Kazem, or anyone else, if they were prepared to pay what Cooper had agreed to pay. The evidence establishes that a $3 million valuation benefited Darvish-Kazem as a 40% shareholder of Pazkaz, as it was a rather generous valuation. At that point, Rave was a relatively new start-up losing between $70,000 and $90,000 a month. An accurate valuation would doubtless have been substantially lower and would have diluted Pazkaz’s interest in Rave.

[13] In the April 2017 email, Pazaratz also advised Darvish-Kazem that he intended to have Rave issue shares to himself in lieu of salary. Pazaratz indicated that the shares would be issued in an amount equivalent to $300,000 a year for the time spent working for the company. Pazaratz has worked, and continues to work, full-time for Rave since August 2013. He has never been paid a salary except by the issuance of shares in Rave beginning in 2017.

[14] There is no evidence in the record to support a contention by Darvish-Kazem that the salary that Pazaratz proposed is unusually high. In any case, it is not a guaranteed salary, but rather is a rather risky proposition for Pazaratz. If Rave succeeds, Pazaratz will be paid for his labour; if Rave does not succeed, Pazaratz’s investment of time and work, not to mention his and his mother’s (as well as Darvish-Kazem’s) money, will have been for nothing.

[15] Since Darvish-Kazem’s departure from the company, Rave has relied for funding on Cooper’s investments, along with research and development grants from the federal government. It also relies on the cash-flow savings it gets from Pazaratz to-date unpaid labour and from exchange of labour for shares in lieu of more salary from certain key employees.

II. The alleged share dilution

[16] Darvish-Kazem contends that the history of dealings with Pazkaz and Rave has resulted in the improper dilution of his interest in those companies. The evidence in the record, however, does not bear that allegation out. What it shows is that both companies have issued shares commensurate with the respective shareholders’ investments.

[17] Since Darvish-Kazem’s departure from the board of Rave in 2017, Rave has only ever issued shares to individuals that have contributed money or labour to the business. In addition to the initial issuance of shares to Cooper in September 2017, Rave issued the following shares in February 2021:

(a) 28 Class B Common shares to Mr. Pazaratz for his work since Darvish-Kazem left the business and returned to medical practice in 2017 (7 shares per year);

(b) 7 Class C Common shares to Lynda Cooper for the funds she has invested into Rave since the last issuance; and

(c) 11.7 Class B Common shares that were promised to five different Rave employees.

[18] As indicated, Pazkaz ceased any further funding of Rave in 2017. However, it remains a substantial shareholder in Rave, owning approximately 40% of the outstanding shares. Darvish-Kazem retains a 40% interest in Pazkaz, while Pazaratz retains a 60% interest.

[19] Darvish-Kazem’s interest has been diluted with the issuance of new shares in Rave, but not improperly so. Rave has received a substantial infusion of cash, and Darvish-Kazem retains precisely the interest that he paid for.

III. Shareholder oppression

[20] In argument before me, the complaints put forward by Darvish-Kazem focused on the dilution of his interest in Rave/Pazkaz. It is his counsel’s contention that this dilution is not only improper, but that it constitutes oppression of a minority shareholder under section 248 of the OBCA.

[21] In the factum submitted by Darvish-Kazem’s counsel, the focus of the oppression remedy analysis is less on the dilution of shareholdings and more on the alleged improper characterization of the contributions to Pazkaz and Rave.

[22] Darvish-Kazem’s counsel puts it as follows:

Michael’s [Pazaratz’s] and Lynda’s [Cooper’s] actions have been oppressive and unfairly disregarded Saeed’s [Darvish-Kazem’s] interests and reasonable expectations, in favour of their own interests. They have refused to:

(a) Properly characterize the Post-2015 Advances as shareholder loans;

(b) Include the Expenses in these calculations and treat them the same as the other advances;

(c) Properly characterize the Rave Advances as loans owing to Pazkaz; and,

(d) Provide audited financial statements.

[23] With the exception of the desire for audited financial statements set out in (d) above, I do not know where Darvish-Kazem’s supposed expectations come from. Likewise, I do not understand how they are reasonable or how the current situation with respect to Darvish-Kazem’s direct interest in Pazkaz and indirect interest in Rave is oppressive.

[24] The Loan Resolution agreed upon by Pazaratz and Darvish-Kazem pertained to Pazkaz alone. It never mentioned Rave and does not apply to Rave. If the two of them, as the original investors in Rave, had wanted to recharacterize Pazkaz’s equity contribution as a loan, they certainly knew how to do so as they did it for their own respective investments in Pazkaz. They would have passed a Rave loan resolution in the same way that they passed the Pazkaz Loan Agreement. But they did not. I find that Darvish-Kazem’s allegation that Pazkaz’s equity investment should have been transformed into a loan might reflect his own desire, but does not reflect a meeting of the minds with Pazaratz or the corporate will of Rave.

[25] In any case, Darvish-Kazem’s complaint in this respect is more form than substance. His counsel cites Flatley v. Algy Corp. for the proposition that “[f]ailing to properly record shareholder loans has been treated as evidence that the offending shareholder has been treating the corporation as if he was the only investor.” It is Darvish-Kazem’s counsel’s submission that this illustrates a form of oppression of a minority shareholder well recognized by the courts.

[26] While on one hand that is an accurate reading of Flatley, it is also a superficial one as it disregards the specific context in which that case was decided. The concern expressed in Flatley was not just that the shareholder loans had not been properly recorded, but that the lack of recording made it impossible to know whether otherwise unexplained payments from the company to family members of the majority shareholder were being accounted for as repayments of the loan. Accordingly, in Flatley, at para 32, Justice Swinton observed that,

[I]n December, 1999, frequent large payments began to appear—for example, payments of $3,345.00 and $1,000.00 in that month, followed by two payments of $1,000.00 each in January, 2000, and other large amounts in the months which follow. At the same time that thousands of dollars appear to have been repaid for [the Respondent’s] shareholder’s loans, the last financial statement shows that the shareholders’ loans have been increasing on the balance sheets.

[27] There is no such suggestion of potential misappropriation or unaccounted for corporate payments in the case at bar. Rave is not profitable; and although both parties are hopeful that it will provide a return on their respective investments one day, it has not yet done so. There is no denying this state of affairs. Neither Darvish-Kazem nor Parazatz has received any payments from Rave or Pazkaz, whether they are characterized as shareholder loan repayments or dividends to shareholders.

[28] In other words, what Darvish-Kazem complains of is not only based on a supposed loan agreement which does not exist, it is not based on any oppressive conduct established in the evidentiary record. Whether he holds debt or equity in the two companies, he has not been deprived of any payments that they have made; and, reciprocally, Pazaratz and/or his family members have not received any payments they have made. While there would be a difference between being a holder of debt and an owner of equity were Rave to become insolvent, the record does not support Darvish-Kazem’s contention that Pazkaz is anything but an equity investor in Rave that has been treated exactly like the other equity investors in Rave.

[29] It is well established that not every unmet, subjective expectation by a shareholder will give rise to a claim of oppression. There must be unfair prejudice or disregard of the minority’s rights: BCE Inc. v. 1976 Debentureholders, 2008 SCC 69, [2008] 3 SCR 560, paras 67, 89. In order to qualify as oppression of a minority shareholder, the conduct complained of must be shown to constitute “oppression”, “unfair prejudice”, or “unfair disregard” of the minority’s interest: Ibid., at para 56. None of those descriptions fit Darvish-Kazem’s situation.

[30] Finally, Darvish-Kazem seeks an Order compelling Pazkaz and Rave to produce audited financial statements. It would appear that those companies have produced only unaudited statements. Pazaratz’s counsel submits that Pazaratz has been transparent about the companies’ finances and that the books and records have been open for Darvish-Kazem to review; and, indeed, there is no evidence that the books and records of the two companies are erroneous in any specific way. But it is clear that no audited financial statements have been done.

[31] Audited statements are not just suggested as good practice; they are required under Part XII of the OBCA. “[A] shareholder’s right to financial information or material concerning the corporation (including audited financial statements) is a clear and mandatory one that is prescribed by the OBCA and vested personally in the shareholder”: McInerney v. RJM Holdings Limited, 2019 ONSC 7179, at para 857. This applies regardless of the size or financial health of the company, although at some point a minority shareholder’s demand for audited financial statements when there is no financial dispute and the company cannot afford the expense may amount to a nuisance request that courts are loathe to endorse: Packall Packaging Inc. v Ciszewski, 2015 ONSC 2837, at para 58.

[32] Under the circumstances, there is some merit in Darvish-Kazem’s demand for audited statements. The parties have developed a substantial amount of distrust of each other, and audited statements may go a long way toward regularizing their relationship. Further, there is nothing in the record that reassures me that unaudited statements of Rave and Pazkaz are as reliable as audited statements. There have apparently been accounting discrepancies in these companies in the past. The parties could have negotiated a shareholders’ agreement or a shareholders’ resolution exempting Pazkaz and, perhaps, Rave, from the audit requirement, but they have not done so.

[33] Given that Darvish-Kazem is a direct shareholder of Pazkaz, he is entitled to audited financial statements of that company. And given that Pazkaz is a direct shareholder of Rave, it is entitled to audited financial statements of that company. I am willing to find that as an indirect shareholder of Rave – i.e. as a shareholder of Pazkaz – Darvish-Kazem is entitled to receive audited financial statements of Rave and has standing under section 248 of the OBCA to obtain a remedy in respect of that right. The courts have been explicit that “[s]hareholders have a right to audited financial statements and a failure to provide them is, at the very least, conduct that unfairly disregards, or is unfairly prejudicial to, their interests: McInerney, at para 862, citing Krandel v. 1714176 Ontario Ltd., 2014 ONSC 4615, at paras 5, 7.

[34] Pazaratz is correct that producing audited financial statements may be a financial burden to an unprofitable company. But in my view, the burden is a necessary one under the circumstances. Of course, as a shareholder of Pazkaz, Darvish-Kazem will either directly or indirectly bear some of the expense of producing audited statements. The oppression remedy is designed to ensure that shareholders at least receive their mandatory statutory entitlements such as audited financial statements, but it does not relieve minority shareholders of the economic burden associated with their position and with enforcing those rights.

IV. Disposition

[35] Unless and until Darvish-Kazem waives his right to them, each of Pazkaz and Rave must, at their respective expenses, produce audited financial statements for any years in which they have carried on business and for which audited financial statements have not been produced.

[36] The Application is otherwise dismissed.

[37] The parties may make written submissions as to costs. I would ask counsel for Pazaratz to send brief written submissions by email to my assistant within two weeks of the date hereof, and for counsel for Darvish-Kazem to send equally brief submissions by email to my assistant within two weeks thereafter.

Date: April 11, 2022 Morgan J.