Court File and Parties

Court File No.: CV-23-00696525-00CL Date: 2023-06-05 Ontario Superior Court of Justice Commercial List

Between: Ed Leavens and Marc Carrafiello, Applicants – and – Abe Schwartz, Respondent

Counsel: Matthew P. Gottlieb, Philip Underwood and Maya Bretgoltz, for the Applicants Sinziana Hennig and Genna Wood, for the Respondent

Heard: May 15, 2023

Before: Penny J.

Reasons For Decision

Overview

[1] In this application, the two minority shareholders of Datex Inc. seek judgment enforcing the “shotgun” buy/sell provision in their unanimous shareholders agreement.

[2] On February 24, 2023, the minority shareholders, Ed Leavens and Marc Carrafiello, made an offer to purchase the shares held by the majority shareholder, Abe Schwartz, in accordance with the terms of the USA. Mr. Schwartz declined to respond to the buy/sell notice of the Applicants. He took the position that the notice was improper. The Applicants contend that, as a result, Mr. Schwartz is deemed to have accepted their offer to buy his shares. Mr. Schwartz argues the buy/sell clause should not be enforced. In the alternative, Mr. Schwartz argues that the matter should not be decided by way of notice of application on a paper record but should be converted into a trial of an action and consolidated with another action, commenced by him, after these proceedings had been initiated.

[3] For reasons I shall explain in more detail below, I find that by not exercising his right to buy out the Applicants at the same price offered for his shares, Mr. Schwartz is deemed to have accepted the Applicants’ offer. The application is granted. I also find that the alternative remedy of consolidation with Mr. Schwartz’s action is not necessary or warranted in the circumstances.

Background

[4] Datex Inc.is an Ontario technology company. Its primary product is “DataStealth”, a cybersecurity product marketed to other businesses across Canada. Datex has three directors: Mr. Leavens, Mr. Schwartz, and Rosemarie Graf, a nominee of Mr. Schwartz. The Applicants are senior executives of Datex. Mr. Leavens is the Chief Executive Officer and Mr. Carrafiello is Chief Information Officer. Mr. Leavens and Mr. Carrafiello have worked for Datex or its predecessors since the early 2000s. Mr. Leavens owns two million shares (about 22% of nine million Datex shares outstanding) and Mr. Carrafiello owns one million (about 11% of the total). The remaining Datex shares are held by Mr. Schwartz. Mr Schwartz is also an officer of the corporation, although he is not, and has never been, an employee. Ms. Graf is not a shareholder, employee, or officer of Datex, although she became a consultant in 2022.

[5] Mr. Schwartz first became involved with Datex in mid-2013. On June 27, 2013, he entered into a “Commercialization Agreement” with Datex and its shareholders. Under this agreement, he acquired a significant proportion of the company’s existing intellectual property for $10. In October 2013, Mr. Schwartz sold this IP to Mitec Technologies Inc., a corporation he controlled, for $1.5 million. Mitec later paid Datex certain amounts of money on account of Datex invoices. There is a dispute about whether these payments were for invoiced development services with respect to the IP, or loans. Datex appears to have invoiced for development services and Mitec expensed its payment of these invoices.

[6] In August 2013, Datex, its shareholders, and Mr. Schwartz agreed that Mr. Schwartz would acquire 51% of Datex’s shares. Ultimately, the share purchase transaction took the form of a September 18, 2013 share purchase and sale agreement under which Mr. Schwartz acquired 51% of the shares of Datex. As contemplated by the purchase and sale agreement, Datex and all of its shareholders entered into the USA, also on September 18, 2013.

[7] As noted, section 3.3 of the USA contains a “shotgun” buy/sell provision, which provides that any shareholder may initiate the process by which one shareholder (or group of shareholders) offers to buy out the other shareholder(s) at a fixed price per share. The offeree has two choices: either he accepts the offer to purchase; or, he elects to buy the offeror’s shares at the same fixed price. The full text of the buy/sell provision states:

The Buy/Sell provision will allow a Shareholder to offer a specific price per share for the other Shareholder(s); shares; whereupon the other Shareholder(s) must then either accept the offer or buy the offering Shareholder’s shares at that specific price per share.

In the event that JIM, LORI , MARC and ED, in this case, collectively the Offeror, issues a Buy/Sell Notice to ABE, in this case the Offeree, the Buy/Sell Notice will contain the following information;

• the signatures of JIM, LORI, MARC and ED
• an unconditional and irrevocable offer to purchase the shares of DI [Datex] beneficially owned by the Offeree
• the price at which the Offeror will purchase the shares of DI beneficially owned by the Offeree

The Offeree shall respond to the Buy/Sell Notice within 15 days of receipt of the Buy/Sell Notice by;

• ABE signing to accept the offer from the Offeror, at which point the Offeror will purchase the shares of the Offeree at the price per share per the Buy/Sell Notice, subject to the provisions of this Agreement; or
• ABE signing to decline the offer from the Offeror, at which point the Offeree will purchase the shares of the Offeror at the price per share per the Buy/Sell Notice, subject to the provisions of this Agreement […]

If the Offeree, in either case, does not respond in accordance with this Agreement to the Buy/Sell Notice within 15 days, it will be deemed that the Offeree has accepted the offer of the Offeror; and will be obligated to sell its shares to the Offeror per the terms of the Buy/Sell Notice. The transaction shall close within 15 days of the date of the response, or failure to respond, from the Offeree.

Notwithstanding the above, in the event that ABE initiates the Buy/Sell provision by way of a Buy/Sell Notice, the per share price offer from ABE will be calculated using a minimum valuation for DI of $5,000,000.00, from which the per share price shall be established in the offer.

[8] The shareholders referred to in this provision as “Jim” and “Lori” have since left Datex. The USA was amended to delete all references to them in 2021. Mr. Schwartz’s shareholdings were increased to 66%. The amending agreement did not otherwise change the terms of section 3.3; it specifically provides that the USA “is and will continue to be in full force and effect, and is hereby ratified and confirmed”.

[9] Under Datex’s by-laws, Mr. Leavens is responsible, as CEO, for exercising general supervision over the affairs of the corporation. The other senior executives of Datex are Mr. Carrafiello; Derek Schenk, its Chief Technical Officer; and Charlie Atkinson, a consultant who serves as its de facto Chief Revenue Officer. These four individuals comprise the Datex senior management team who are collectively responsible for the day-to-day operations of Datex.

[10] Between 2013 and mid-2022, Mr. Schwartz and Ms. Graf (following her appointment to the board in mid-2020) had limited involvement in the operations or management of Datex. There were no formal board meetings or shareholders’ meetings. Mr. Leavens met with Mr. Schwartz periodically to give him updates about the business on an informal basis and Mr. Schwartz provided input to Mr. Leavens during those meetings.

[11] As a result of various concerns, in mid-2022, Mr. Schwartz and Ms. Graf became more involved in the day-to-day affairs of the corporation. Mr. Schwartz became involved in the hiring of new salespeople and Ms. Graf to begin attending weekly sales staff meetings. Mr. Leavens also participated in bi-weekly update calls with Mr. Schwartz and Ms. Graf to give them updates on the status of the business.

[12] By the latter part of 2022, the relationship between Mr. Schwartz and Mr. Leavens and the other members of the senior management team began to break down. This was largely the result of a fundamental difference in vision between the parties regarding the future of the business. In simple terms, Mr. Schwartz wanted Datex to cut costs and prepare itself for a hypothetical sale to a larger entity, while the senior management team wished to continue developing new products and seeking out new customers in order to increase Datex’s revenues. There were, however, growing personality conflicts as well between Mr. Schwartz and senior management.

[13] In late November and early December, 2022, while Mr. Leavens was on vacation, Mr. Schwartz set up meetings with other members of the management team. While there is dispute about what exactly was said in these meetings, the senior management team became very upset with Mr. Schwartz. Following Mr. Leavens’ return from vacation, Messrs. Schenk and Atkinson advised Mr. Leavens that they were unhappy with Mr. Schwartz’s behaviour, and his plans for Datex, and that they would prefer not to continue working with him in the future.

[14] In early February 2023, Mr. Schwartz and Ms. Graf told Mr. Leavens they were planning to cut Datex’s staff and to sell Datex to a strategic buyer. The sale plan was a hypothetical one, in the sense that no “strategic buyer” for Datex had been sought by or approached the company. The senior management team felt that Mr. Schwartz’s plans were unwise and likely to harm Datex and its employees. They felt that their relationship with him had reached a breaking point. Although they wanted to remain at Datex, the executives did not wish to continue working with Mr. Schwartz if they could avoid it. The senior management team decided that a management buy-out was the best approach to allow for an amicable separation.

[15] Mr. Leavens and Mr. Schenk brought this proposal to Mr. Schwartz during a call on February 12, 2023. Mr. Schwartz said that he did not expect to agree to being bought out, but that he would consider the offer. At the next meeting on February 14, Mr. Schwartz told Mr. Leavens he would not accept a buy-out of his shares, and also would not agree to buy out the Applicants’ shares. As a result, he told Mr. Leavens that the only options were to sell Datex to a strategic purchaser or to shut the company down.

[16] In the face of Mr. Schwartz’s refusal to consider a management buy-out, the Applicants decided to make a binding offer to Mr. Schwartz under to the buy/sell provision in section 3.3 of the USA. They delivered the buy/sell notice on February 24, 2023. It is not in dispute that the buy/sell notice complied with the formal requirements of the USA: it was signed, contained an unconditional and irrevocable offer to purchase Mr. Schwartz’s shares, and set out the price which the Applicants offered to pay: $1.16 per share, for a total of $6,960,000 payable to Mr. Schwartz.

[17] On February 27, 2023, Mr. Schwartz emailed the Applicants to confirm his receipt of the buy/sell notice and asked for information and documentation about Datex’s business. Mr. Leavens provided a response to this request two days later, on March 1. Mr. Schwartz emailed the management team on March 6 with further questions and Mr. Leavens provided responses the following day.

[18] Under the USA, Mr. Schwartz was required to respond to the buy/sell notice within 15 days of receipt (i.e., by March 11, 2023) by either: accepting the offer to purchase his shares or by agreeing to purchase the Applicants’ shares at the price offered in the buy/sell notice. He did not do so. Instead, on March 10, Mr. Schwartz advised by letter that he was refusing to buy the Applicants’ shares or to sell his shares to them.

[19] This is what has prompted the present application by Mr. Leavens and Mr. Carrafiello, commenced on March 20, 2023, to enforce the buy/sell provision. Mr. Schwartz responded to the application. Pleadings were closed April 10 with the delivery of the Applicants’ reply record. Mr Schwartz commenced an action against the senior management team by issuing a statement of claim on April 13, 2023. The statement of claim seeks damages and a broad array of relief in tort and under the oppression remedy.

Issues

[20] The central issue on this application is whether the buy/sell notice should be enforced. This breaks down into three sub-issues:

(a) Did the buy/sell notice comply with the requirements of section 3.3 of the USA?

(b) If yes, did Mr. Schwartz have lawful grounds to refuse to respond to the buy/sell notice? and

(c) Whether the determination of the second question requires converting this application into a trial and consolidation with Mr. Schwartz’s action alleging oppression under the OBCA.

Analysis

Issue #1: Did the Buy/Sell Notice Comply with the USA?

[21] Buy/sell provisions are an everyday feature of shareholders’ agreements because they provide a minimally intrusive, expeditious, cost-effective, and accurate mechanism for shareholders to dissolve their relationships when they can no longer get along. The Court of Appeal has found that shotgun clauses protect the interests of all parties by “ensuring that the pulling of the trigger generates the best and highest price in exchange for the involuntary termination of the shareholders’ relationship”: Aronowicz v. Emtwo Properties Inc., 2010 ONCA 96 at para. 50. A buy/sell provision achieves this result by ensuring that “the shareholder who first activates it does so at a price per share sufficiently high that he would be prepared to be bought out himself” at that price: Aronowicz, at para. 51. However, because the effect of a buy/sell provision is to involuntarily expel one party from an otherwise viable business venture, strict compliance is required: Western Larch Ltd. v. Di Poce Management Ltd., 2013 ONCA 722 at para.42.

[22] That said, the court’s role is not to rescue a party who later regrets contractual arrangements that were carefully designed and accepted. The court’s task is to consider whether compliance with the shotgun buy-sell provision is sufficiently strict, given the vagaries and complexities of commercial arrangements and commercial life, which the parties have plainly accounted for in their contractual arrangements. Strict compliance is not perfect compliance: Western Larch, at para. 46.

[23] The buy/sell notice in this case complies strictly with the terms of the USA. It tracks the language of section 3.3 precisely, including all of the required terms from that section and no additional ones. The notice: (1) is signed by the offerors, Messrs. Leavens and Carrafiello; (2) states that it contains an unconditional and irrevocable offer to purchase the shares beneficially owned by the offeree, Mr. Schwartz; and (3) includes the price at which the offerors will do so. For the avoidance of any doubt, the buy/sell notice also states that it is made under the terms of section 3.3 of the USA.

[24] On receiving the buy/sell notice, Mr. Schwartz had two options: to purchase the shares of Messrs. Carrafiello and Leavens for the offer price, or to sell his own shares to them at the same price. The language of the USA on this point is clear and mandatory: it states that, on receipt of a buy/sell offer under section 3.3, the offeree “must then either accept the offer or buy the offering Shareholder’s shares at that specific price per share”, and that he or she “shall respond to the Buy/Sell Notice within 15 days of receipt” by either signing to accept the offer or to decline it. In the event the offeree fails to respond within 15 days, the USA states that “it will be deemed that the Offeree has accepted the offer of the Offeror, and will be obligated to sell its shares to the Offeror per the terms of the Buy/Sell Notice”, with that transaction to close within 15 days from the date of deemed acceptance.

[25] Mr. Schwartz did not respond by making the election required by the buy/sell notice within the 15-day period specified in the USA. By failing to do so, he is deemed to have accepted the offer to sell his shares at the specified price and, subject to the considerations under issue #2, is obliged to do so. The Applicants were (and are) ready, willing, and able to close the transaction.

Issue #2: Did Mr. Schwartz Have Sufficient Grounds to Refuse to Respond to The Buy/Sell Notice?

[26] Mr. Schwartz advances three reasons why the buy/sell notice should not be enforced in accordance with section 3.3 of the USA.

[27] First, he argues that the conduct of senior management (including Messrs. Leavens and Carrafiello) in threatening to resign if he were to take over the company, was calculated to defeat the intent of the buy/sell provision. This was contrary to the obligation of honesty and good faith performance. The Applicants offered a “grossly undervalued” price because they were not genuinely prepared to be bought out at that price; they sought to prevent Mr. Schwartz from exercising his option to buy through the threat of mass resignation.

[28] Second, Mr. Schwartz argues that he held a reasonable expectation that Messrs. Leavens and Carrafiello and the other senior management would honour their contractual and common law duties to the company. This reasonable expectation was defeated by the threat of mass resignation. This was oppressive behaviour warranting an order setting aside the buy/sell notice.

[29] Third, Mr. Schwartz argues that the Applicants’ conduct was in breach of implied terms that the offeror would offer to buy or sell the shares of the business in the same condition, and more specifically, that the offeror would not threaten to impair the company’s ability to operate if the offeree exercised the right to buy.

[30] I will add by way of overview that Mr. Schwartz has dredged up a host of other complaints about the Applicants’ prior conduct in relation to bonuses, hiring and management of staff and other matters. These make up the bulk of Mr. Schwartz’s action. In my view, none of these matters are relevant to the central issue before the court on this application. The issue, in my view, turns almost entirely on whether, as Mr. Schwartz alleges, the Applicants conspired with other senior managers to breach, or threatened to breach, their common law duties to Datex to provide reasonable notice of the termination of their employment and, in Mr. leavens case, threatened to breach his obligation not to compete against Datex. The formulation of Mr. Schwartz’s arguments seems, on the whole to share this view, as these latter issues were the focus of almost all the submissions on his behalf.

Duty of Good Faith

[31] Mr. Schwartz argues that the Applicants breached their duty of honest and good faith contract performance by (i) undermining Mr. Schwartz’s legitimate interests by exercising the buy/sell provision dishonestly, offering a price for the shares of a company with a hollowed-out management team knowing that he would not accept; and (ii) exercising the buy/sell provision unreasonably and contrary to its purpose. Contracting parties may not engage in conduct that “eviscerates or defeats the objectives of the agreement that they have entered into.” Although the duty of good faith in the context of a buy/sell provision is narrow, the Court of Appeal has recognized that there is a “good faith obligation not to act in a fashion that eviscerates the very purpose of the agreement”: Aronowicz at para. 50.

[32] The essential facts in support of this argument boil down to Mr. Schwartz’s allegations of what took place at a meeting he had with Mr. Leavens on March 2, 2023. He says Mr. Leavens threatened that if Mr. Schwartz exercised his right to buy in response to the buy/sell notice, the management team would walk out immediately and use Mr. Schwartz’s money to start a competing business, in breach of their contractual non-competition covenants and fiduciary duties owed to Datex. He says Mr. Leavens also threatened that their immediate departures would leave the company unable to support DataStealth and expose clients, who are major Canadian and international companies, to the risk of cyberattacks almost immediately.

[33] These allegations are denied by Mr. Leavens and Mr. Schenk, who both testified that while they did want to leave if Mr. Schwartz took over the company, they always and only intended to do so in compliance with their contractual and common law duties to the company. Mr. Leavens specifically denied making the threats alleged by Mr. Schwartz.

[34] On March 6, 2023 Mr. Schwartz wrote to each member of the management team separately, indicating his understanding that they all intended to leave Datex if he remained an owner and asking what consequences their departures would have, what succession planning was in place, and who would assume their responsibilities.

[35] Mr. Leavens responded on March 7. He said:

As you are aware, over the last 6-9 months, when we have requested and received budget approval, we have added senior resources to transfer operational responsibilities for day-to- day operations. The senior management team provides cross-functional coverage for each other for risk mitigation and succession planning purposes. At present, due to the lack of budget approval from you, there are not sufficient resources to cover all of the duties of the management team as a whole. In the event of a change of the entire management team, without knowing who the replacement employees will be, there is no way to establish a viable succession plan.

[36] On March 10, the day before the deadline for exercising his rights under s. 3.3 of the USA in response to the buy/sell notice, Mr. Schwartz wrote to the Applicants, stating that the notice was invalid in light of the threats made to prevent him from exercising his right to buy, but that he was prepared to buy at the price in the buy/sell notice if the management team would agree to provide “appropriate transition services in good faith over a mutually agreeable period of time.”

[37] The response from Applicants’ counsel came after the expiry of the 15 day notice period. It denied the allegations made by Mr. Schwartz. It did not address Mr. Schwartz’s request for assurances regarding “appropriate transition services”.

[38] While the Applicants bear the ultimate burden of proving they are entitled to an order enforcing the buy/sell provision in accordance with its terms, they have established, as explained in the analysis of Issue #1, that they complied with the strict terms of the buy/sell provision and are prima facie entitled to the remedy they seek. Mr. Schwartz seeks to avoid the consequences of the buy/sell provision on other grounds. Thus, the tactical, or evidentiary, burden shifts to Mr. Schwartz to show good reason why the provision should not be enforced – specifically, that the buy/sell notice was exercised in bad faith. I find that he has not discharged this burden.

[39] Mr. Schwartz did not have the right to expect that all of Datex’s employees would stay at the company indefinitely if he purchased its shares. The employment contracts of senior management are not for fixed terms. The possibility that the senior management team could leave Datex should Mr. Schwartz purchase its remaining shares and impose his vision on the company did not, standing alone, have the effect of “eviscerating” his purchase right under the buy/sell provision. It is a fact of business that employees can resign for any reason, including disagreements with the direction chosen by owners or managers. The senior management team were entitled to leave, on certain terms and conditions which I will discuss below, and were certainly entitled (indeed, one might say in the circumstances, obliged) to advise Mr. Schwartz of their intention to do so.

[40] What the senior management team could not do, of course, is resign in a manner which breached their common law and contractual obligations to Datex. Mr. Leavens also had a non-competition clause in his employment agreement. All four of the senior management team were obliged, at common law, to give reasonable notice of the termination of their employment. An employee is obligated to give reasonable notice of termination to his employer. The appropriate notice period is generally determined by the responsibilities, length of service, salary, as well as the time it would reasonably take the employer to replace the employee or otherwise take steps to adapt to the loss of that employee: Sure-Grip Fasteners Ltd. v. Allgrade Bolt & Chain Inc., 1993 CarswellOnt 931.

[41] Both Mr. Leavens and Mr. Schenk have testified that it was always their intention to comply with these obligations. Mr. Leavens denies that he threatened to resign immediately and, in breach of his contract of employment, set up a competing business. Although both Mr. Leavens and Mr. Schenk were cross examined on their affidavits, neither was cross-examined on this evidence specifically.

[42] Mr. Schwartz’s allegations of what Mr. Leavens said in their March 2 meeting is not consistent with his March 6 letter to senior management. Mr. Schwartz does not allege any breach of law or obligation or threatened breach of law or obligation. He acknowledges the admitted desire of the senior managers to leave if he were to take over the company and asks for information about what consequences their departure would have, what succession plan was in place and who would assume their responsibilities. Mr. Schwartz did not ask specifically when they proposed to leave or raise their legal obligations in terms of notice etc. The candid response to Mr. Schwartz’s questions from Mr. Leavens was that they did not know what the succession plan would look like. That, presumably, was a discussion that would have to take place if he exercised his right to purchase the Applicants’ shares.

[43] I would also add that Mr. Schwartz’s allegation that Mr. Leavens solicited or conspired with the other members of the senior management team to induce them to resign unlawfully is entirely without evidentiary support. It is denied by Mr. Leavens and Mr Schenk. Mr. Schwartz admitted on cross examination that he has no evidence to support this allegation.

[44] Mr. Schwartz was entitled to expect, and to insist, that the senior management team comply with their contractual and common law obligations to Datex. The evidence, which I accept, is that they intended to do so. That the circumstance of their potential departure introduced an element of risk for Mr. Schwartz is undeniable. But it was a risk that existed in any event. And, as the Applicants submit, it was a risk which could have been mitigated in the ordinary course by providing incentives for existing employees to stay: for example, by insisting on their common law obligation to give reasonable notice, insisting on compliance with contractual non-compete provisions, offering increased compensation or stock options and by hiring new employees to replace them during the notice period. Mr. Schwartz made his decision not to respond to the buy/sell notice without even asking when the senior managers were proposing to leave.

[45] It may well be that definitive resolution of some of these mitigating strategies required time, but 15 days is what the parties to the USA agreed to. And, it was Mr. Schwartz’s choice not to raise these issues until March 6, not the Applicants’.

[46] In any event, had Mr. Schwartz chosen to purchase the Applicants’ shares, he could have taken these or other steps to protect his interests. If his personal opinion regarding the value of Datex is accurate, it would have been economical to do so. He says Datex is worth in excess of $150 million. The buy/sell notice gave him the opportunity to acquire all of Datex’s outstanding shares at a valuation of $10.4 million, such that the company could have been entirely his for about $3.4 million. Mr. Schwartz could have acquired the remaining shares and used some of he says is more than $140 million in implied surplus value, to retain the existing senior management or hire replacements for them, and profited from the difference. He was, of course, not required to do this but his decision to not buy the Applicants’ shares at the offered price has consequences, namely the obligation to sell his own shares to the Applicants at that price.

[47] As the Court of Appeal said in Western Larch, the court’s role is not to rescue a party who later regrets contractual arrangements that were carefully designed and accepted. The USA was negotiated and executed with the benefit of legal advice. The evidence reveals that the parties also had the benefit of legal advice throughout the buy/sell notice period. The whole point of buy/sell provisions is to have a minimally intrusive, expeditious, cost-effective, and accurate mechanism for shareholders to dissolve their relationships when they can no longer get along. Mr. Schwartz testified that he was prepared to buy at the price in the buy/sell notice if the management team would agree to provide “appropriate transition services in good faith over a mutually agreeable period of time.” The senior management team had legal obligations to provide reasonable notice. The management team has testified that they were prepared to do so, in accordance with their common law obligations. Mr. Schwartz, as 100% owner of the company, would have been in a position, in any event, to insist that they do so.

[48] Counsel for Mr. Schwartz asks for an adverse inference to be drawn about the alleged intentions of senior management because neither Mr. Carrafiello nor Mr. Atkinson gave evidence. There is no basis for an adverse inference. Not every person who has knowledge of the same events must be called to testified about those events. More importantly, Mr. Schwartz was entitled to examine both these men as witnesses on a pending application; he chose not to do so.

[49] For all these reasons, I find that Mr. Schwartz has not met his evidentiary burden of showing the Applicants breached their duty of honesty and good faith in contract performance with the effect of eviscerating or defeating Mr. Schwartz’s rights under the buy/sell provision and notice. He could have exercised his right to buy out the Applicants and had ample opportunity to, and means of, managing the risks, including employee resignations, of doing so.

Oppression

[50] Mr. Schwartz argues that he held a reasonable expectation that the Applicants would not in concert with the other senior managers unlawfully thwart his option to buy or sell at the price fixed in the buy sell notice. He says that his reasonable expectations were defeated by the Applicants’ conduct in allegedly soliciting the other senior managers to leave and threatening mass resignation without notice and unlawful competition prohibited by Mr. Leavens employment contract with Datex.

[51] The oppression argument is essentially a repackaging of the good faith argument. I accept that Mr. Schwartz could reasonably have expected the Applicants and the senior managers to comply with their contractual and common law obligations. However, as discussed above, I am not satisfied Mr. Schwartz has established that the Applicants and senior managers breached (or even threatened to breach) those obligations. Thus, while the expectation may have been reasonable, the conduct constituting oppression which could have defeated those expectations has not been proven. The evidence is that the Applicants and senior managers were prepared to comply with their legal obligations. Employee resignations were a risk Mr. Schwartz faced in any event. He may well have decided not to take that risk but the consequence of doing so is that he is deemed to have accepted the Applicants’ offer to purchase his shares.

[52] For these reasons, the Respondent’s oppression argument does not warrant setting aside the buy/sell notice as invalid.

Implied terms

[53] In the further alternative, Mr. Schwartz argues that the Applicants’ conduct was in breach of four implied terms of section 3.3 of the USA. The alleged implied terms were:

(a) any buy/sell transaction would take place on reasonable commercial terms, including a management transition period;

(b) any offer made under the buy/sell provision would be a genuine offer of an amount that the offeror would accept for their shares. Specifically, that the exercise of the buy option in a buy/sell scenario would result in acquiring the business in the same condition in which it would be sold under the sell option;

(c) adequate and accurate information about the business would be provided to the offeree to enable them to make their decision; and

(d) the shareholders who were officers and directors of Datex would provide appropriate transition services such that Datex would remain operable as a going concern.

[54] I do not accept this argument for several reasons.

[55] Section 8 of the USA precludes implied terms. It specifically provides that there are no conditions, representations, warranties or other agreements between the parties in connection with the subject matter of the USA, whether oral or written, expressed or implied, statutory or otherwise, except as specifically set out in the USA. Terms are implied only where necessary to reflect the intentions of the parties. Here the express intention of the parties was to exclude implied terms from the USA. While I accept that, as a matter of law, language of this nature does not necessarily preclude the court from implying terms in any event (when the legal preconditions for doing so are met are met), I find that this entire agreement clause provides important context in evaluating the strength and viability of Mr. Schwartz’s arguments as to why he ought not to be bound by the buy/sell provisions of the USA.

[56] More importantly, the implication of terms is a narrow category of judicial intervention, to be employed only where absolutely necessary to give business efficacy to the agreement. It must be based on evidence. Here, all we have is Mr. Schwartz’s bald conclusory statement – a statement of argument, not fact.

[57] The implication of these terms is not necessary. This is largely because the substance of the alleged implied terms is already dealt with in the USA or required by the common law. The requirement of “reasonable commercial terms” is inherent in section 3.3, which sets out the obligatory terms for any buy/sell transaction. It is also inherent in the common law obligation to give reasonable notice. The alleged implied term requiring that the offer price be one the offeror would accept for their own shares is also inherent in section 3.3, which grants the offeree an irrevocable option to purchase the offeror’s shares at that price. I have already found that the Applicants and senior managers were required at law to fulfill their obligations to give reasonable notice of their resignations and, in Mr. Leaven’s case, not to compete against Datex. However, as I have also found, there is no satisfactory evidence of any breach or threatened breach of those obligations. There is no basis or need to “imply” those obligations. The “adequate information” term is addressed by section 2.3 of the USA, which requires Datex to give its shareholders any financial or business information they may reasonably request. I find on the evidence that there was substantial compliance with this requirement.

[58] Mr. Schwartz makes much of his opinion that the pricing of the Applicants’ buy/sell notice vastly understated the value of the company. However, there is no requirement, under the USA or as a matter of law generally, that the terms of a buy/sell offer reflect the fair market value of the company. Indeed, one of the purposes of a buy/sell provision is to avoid the need to value the business, which can be an expensive, time-consuming, and contentious process. The price discovery function of buy/sell provisions was addressed by Epstein J. in Classic Organ Co v Artisan Organ Ltd (1997), 1997 CarswellOnt 1773 (Ont. Gen. Div.) at para. 33: “there is no better way for a person to put a fair value on what he or she owns than to agree upon a price for which they would be prepared either to buy or to sell”. The parties chose to incorporate this mechanism into the USA. They chose not to include a valuation requirement, although they turned their minds to the issue generally by imposing a price floor on any offer made by Mr. Schwartz (but not any other offering party). Where the parties choose not to include a valuation requirement in a shareholders’ agreement, it is not the court’s role to add one: Western Larch, at para. 46.

[59] For these reasons, therefore, I find that there is no basis to imply the terms argued for by Mr. Schwartz.

Issue #3: Conversion and Consolidation

[60] Finally, Mr. Schwartz argues that if the Court based on the current record is unable to determine whether Mr. Leavens made the threats alleged by Mr. Schwartz, the application should be converted to an action and consolidated with Mr. Schwartz’s action for trial.

[61] The short answer to this submission is that I have determined, based on the evidence, that Mr. Schwartz has not shown there was a breach, or threatened breach, of the Applicants’ and senior managers’ duties to Datex. I should note in passing that most of the alleged duties are not owed to Mr. Schwartz personally. The relevant duties are owed to Datex, not to Mr. Schwartz. The point is worth making because there is a suggestion, among other things, that the Applicants owed duties of a fiduciary nature to Mr. Schwartz in relation to the exercise of the buy/sell provision. A buy/sell offer does not give rise to fiduciary obligations between shareholders. This is because there is no undertaking by one party to act on behalf of another -- a buy/sell provision represents “the quintessential corporate mechanism for the exercise of shareholder self-interest”. It is “hard to conceive of a corporate/commercial mechanism less likely to attract the operation of fiduciary obligations”: The defining attributes of a fiduciary relationship are not present; to the contrary, the buy/sell context is characterized by economic competition between the shareholders, which is “the very antithesis of [fiduciary] attributes”: Aronowicz, at paras. 50 and 54. To be sure, the senior management team may have owed obligations to the company, but these obligations are not tied to the Applicants’ right to make an offer under the buy/sell provision.

[62] Further, the validity of the buy/sell notice is the only claim common between the application and the action. The allegations Mr. Schwartz raises in the action are distinct from, and much broader than, the material facts engaged by the application. In support of the claims in his action, Mr. Schwartz alleges, among other things, that: (a) Mr. Leavens and Mr. Carrafiello had engaged in self-dealing by paying unauthorized bonuses to themselves and others; (b) Mr. Leavens engaged in unauthorized hiring of employees and approved unauthorized employee pay increases; (c) Mr. Leavens compensation structure exposed Datex to potential liabilities; and (d) Mr. Leavens breached his employment agreement and failed to comply with the terms of his option grant agreement. These allegations, in my view, have no impact on the validity or enforceability of the buy/sell notice.

[63] I find the decision of Pattillo J. in Sandiford v 210458867 Ontario Inc., 2012 ONSC 5825 to be of assistance as well. Similar to the circumstances here, the applicant in Sandiford sought enforcement of a buy/sell notice and offer. The respondent also brought a subsequent action alleging conspiracy, breach of provisions of the unanimous shareholder agreement and oppression. The respondent relied on its claims in the action in connection with its response to the issues regarding the validity of the buy/sell provision. The relief claimed in the action included, among other things, an order requiring the applicant to sell their shares to the respondent at fair market value or alternatively, damages. Justice Pattillo found that the issues raised in the action should be dealt with independently from the application. He emphasized that “given the issues involved in the Application and the current deadlock”, he did not consider it appropriate to consolidate as the “delay which would occur, even with an expedited timetable, would be detrimental to the company and the shareholders”: Sandiford, at paras. 8-10 and 13-14.

[64] Justice Pattillo did find that there was an issue relating to the application requiring a mini-trial, however. He scheduled that for a one day hearing within a matter of weeks. His decision on the main application (2012 ONSC 5825) was rendered following that hearing.

[65] I would also emphasize again that the buy/sell provision is meant to allow an expeditious, relatively inexpensive separation that accomplishes “leaving the potentially healthy, profitable business intact”. To require a trial of the buy/sell notice in this case would result in a protracted and complex process, contrary to the intention and purpose section 3.3 of the USA. It is clear that the effect of such a protracted process would be very, if not fatally, damaging to the company.

[66] Mr. Schwartz maintains that there is a credibility issue: he says threats were made in a meeting of March 2; Mr. Leavens says they were not. Mr. Schwartz says the senior management team were going to resign immediately en masse; Mr. Leavens and Mr. Schenk say they were not. This, he argues, requires a trial.

[67] There are two points to make in response to this argument. First, even if I agreed with the Respondent that the issue of whether threats were made and vitiated the exercise of his right to purchase under the buy/sell provision, like Justice Pattillo in Sandiford, I would have found that the remedy would not be converting the entire application into a trial and consolidation with Mr. Schwartz’s action. The remedy would be a short evidentiary hearing focussed on this specific point in dispute.

[68] Second, and more importantly, what the Respondent has failed to demonstrate is how the court will be in any better position to decide the question following an evidentiary hearing on this point than it is now. Issue was joined on this point in the affidavits. Cross examinations were conducted, although the Respondent chose not to cross examine Mr. Leavens specifically on what was said at the March 2 meeting and what his intentions were regarding his common law obligations and under his non-compete. It is now well accepted that “witness demeanour” is an inadequate, and possibly misleading, basis upon which to resolve credibility questions. Rather, the determination must be based on objective criteria: consistency with documents, consistency with other evidence, etc. Here the only documentary evidence is not consistent with Mr. Schwartz’s allegations. As noted earlier, his memo to the senior management team on March 6, following the meeting with Mr. Leavens, says nothing about alleged threats or conspiracies. Mr. Leavens’ response is candid but carries no hint that he or the other senior managers were threatening to resign immediately and en masse in breach of their common law obligations.

[69] For these reasons, the alternative remedy of an order converting the application into an action and consolidating that proceeding with the Respondent’s action requested by the Respondent, is denied.

Conclusion

[70] For the reasons set out above, the application is granted. Mr. Schwartz is deemed to have accepted the Applicants’ offer to purchase his shares in Datex for $1.16 per share for a total of $6,960,000. The alternative remedy requested by the Respondent for a consolidation order is denied.

Costs

[71] The parties both submitted cost summaries. The Applicants’ partial indemnity request for costs was about $230,000. The Respondent’s partial indemnity request for costs was about $105,000. Having regard to the factors outlined in R. 57, including the amount that the unsuccessful party could reasonably expect to pay, I find that the Applicants are entitled to partial indemnity costs in the amount of $125,000, inclusive of fees, disbursements and all applicable taxes.

Penny J. Released: June 5, 2023