RSM225H1 Study Guide - Final Guide: Oppression Remedy, Board Of Directors, Fiduciary

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16 Feb 2016
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RSM 225 FALL 2014 - MIDTERM general guide this is not intended to be a sample
response but rather a general guide to issues that could be identified and discussed. NOT
PROOFREAD
QUESTION ONE (60 marks) (54 minutes)
UT has recently added a corporate governance course to its Executive Program. The course is intended
to help individuals that will be taking on the role of a corporate director, bankers that lend to corporations,
and others better understand how corporations are directed and controlled. The course is taught using a
series of simulated situations (simulations). The individual that was hired to prepare some of the course
material has written some simulations, but due to a family emergency has had to leave. You, Bea Calm,
have now been hired on a part time basis to prepare a solution guide for Simulation One. Your
instructions are to identify legal issues; provide a detailed legal analysis of the issues, with relevant
conclusions, and where appropriate provide practical advice to avoid those issues. As part of your
solution guide, you are asked to discuss any legal rights or remedies available to the shareholders and
creditors of DI. (this para provides information as to the role and user; students should keep this in mind
when the develop their response. As it is a solution guide it should be fairly detailed in analysis and
technical support. A good response will be organized and structured and not just a “dumpof technical
knowledge.)
Simulation One Disko Inc. (“DI”) manufactures compact discs. DI is a private corporation with 10
shareholders, including Heather Case and her two sons, Justin Case and Mike Case. The three of them
hold sixty percent of the common shares and are also the only directors of DI. Justin and Mike run the
business. Heather has very little business experience, having inherited her shares from her husband.
Accordingly she takes on no significant role. Heather does attend the director meetings for which she is
well compensated. She pays no attention at any of the meetings, instead just agreeing with what her sons
want. [Relevant facts The Case family are the majority shareholders; in addition to being shareholders
the three are directors and Justin and Mike are likely officers given they “run the business”. In their role
as directors and officers they would have obligations (fiduciary) and would be required to act
appropriately (avoid conflicts; do not take corporate opportunities etc.); (integrate later into possible
issues/remedies) Issue: Is Heather as a board member acting appropriately.
Analysis: Law: 134. (1) Every director and officer of a corporation in exercising his or her powers and
discharging his or her duties 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. R.S.O. 1990, c. B.16, s. 134 (1).
Pays no attention; votes the way her sons want her to.
Conclude: Heather is breaching her duties as a board member.
In 2012, Justin incorporated Money Source Inc. (“MSI”). Justin is the sole shareholder and director of
MSI. MSI borrowed $3 million dollars from DI in order to fund its new operations. The loan was approved
by the DI directors. MSI subsequently paid the $3 million to Justin as a director honorarium” and as
dividends.
(integrate later into possible issues/remedies) Issue: Was it appropriate for the DI directors to
approve the loan. Analysis Directors have to act in the best interest of the corporation. In granting the
loan, the directors should have considered the financial condition of DI (as we note later it is unable to
pay its creditors). The directors should have considered DI cash flow; they should have been diligent as
to what MSI was going to use the funds for and ensured clear terms of interest and principal repayment.
The loan should have been secured with adequate collateral. Conclude: In approving this loan, the
directors breached their duty to exercise care, diligence and skill.
Issue: Was Justin a director that approved the loan; and/or was the approval of the loan by
sibling/mother a conflict of interest.
Analysis OBCA/CBCA require directors/officers to disclose conflicts and not participate in any vote
pertaining to same. Conclusion: conclude on conflict/breach (integrate later into possible issues/remedies
e.g. loan set aside)
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Issue: Justin has removed all funds from operations In making a claim against DI to collect the
loan, can Justin be added as a defendant pierce the corporate veil.
Analysis Dividends are generally paid from retained earnings (after tax profits) As well a payment to a
director has to be bona fide (cannot just award and honorarium). Appears that Justin incorporated the
company to act as a veil to perpetrate a fraud. DL in making a claim seek court permission to name
Justin; requires to show Justin controlled the company; used control to commit a fraud; this misconduct
is the direct cause of the harm (financial loss). Conclusion: Consistent with analysis.
Issue: Validity of dividends paid by MSI to Justin. Analysis OBCA etc. in order to pay a dividend
must pass 2 tests 1. Solvency test; 2. Capital maintenance test. Conclusion: consistent with discussion
(require dividend to be repaid; liability of director that declared it)
In 2012, the directors of DI approved a re-organization of share capital. Articles of Amendment were filed
that essentially converted the common shares into three new classes of shares, Class A Common, Class
B Common and Class C Common. The re-organization converted Justin and Mike’s common shares to
Class B Common shares and Class C Common shares, and all the other shareholders’ common shares
(including Heather’s) to Class A Common shares. Once complete, a directors resolution was passed by
Justin and Mike paying a significant dividend on the Class B Common shares and Class C Common
shares. Apart from Justin, Mike and Heather, none of the other shareholders were aware of the
reorganization.
Issue. The re-organization of share capital Is this a fundamental change that requires S/H
approval and special resolution (2/3 vote). Analysis The re-org of share capital fundamental
change. Requires a 2/3 shareholder approval. This does not appear to have been completed.
Accordingly this revision would be invalid. AND / OR students could also discuss/integrate appraisal
remedy (the main point would likely be that the restructuring was not valid and so in turn the payment of
dividends was invalid as well as Class B, Class C are not bona fide shares.
(students could also discuss dividend payment and validity given solvency test, capital maintenance)
In 2013, Mike and Justin incorporated Modern Flash Drives Ltd. (“MFDL”). MFDL manufactures high
speed memory sticks. Many of the customers of MFDL were customers of DI (e.g. BestBuy, FutureShop).
Much of the equipment used by MFDL was purchased from DI after the purchase was approved by the DI
directors.
Issue: Was there a breach of fiduciary duties (inappropriate action of director/officers.
Analysis It could be that Mike and Justin actions (incorporating MFDL; moving equipment; competing;
using same customers etc. breached fiduciary duties by making use of confidential information; taking
of a corporate opportunity (other valid). Implications DI has been harmed by these actions and should be
making a claim against Mike, Justin, Heather. As they are likely not going to commence against
themselves opportunity to discuss derivative action (requirements; implications payment made to DI
which could then be used be creditors)
Issue: Ability of parties (creditors/minority shareholders) to commence oppression remedy.
Analysis facts would support that many actions take are unfairly prejudicial; integrate facts;
demonstrate that understand oppression remedy (applicant is oppressed party creditor/minority
shareholder) going directly after Mike, Justin etc. Conclude
In 2013, the board of DI approved the financial statements of DI. Heather was at the meeting but did not
look at the financial statements. Accordingly she did not notice the large receivable from MSI which,
because MSI never commenced any form of operations, MSI had no assets to repay, and would have to
be written off. Shortly after that board meeting, Justin and Mike resigned as directors. (see discussion
above. The fact that Justin and Mike resigned does not eliminate their potential liability as acting
inappropriately as directors/officers.
Within two months, DI was no longer able to pay its creditors, largely because the loan to MSI had to be
written off. A court appointed trustee has determined that DI is essentially bankrupt, and will not be able
to pay most of its debt nor have anything for its shareholders. Heather was recently quoted in the
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