What Every Shareholder Needs to Know about the Supreme Court of Canada’s Latest Word on Good Faith

Like all contracts in Canada, shareholders’ agreements are bound by a duty of good faith. At common law, this includes the duty to act honestly and to exercise any discretion under the agreement reasonably: C.M. Callow Inc. v. Zollinger, 2020 SCC 45; Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7.

In the context of a share purchase, however, does this duty require a purchasing shareholder to disclose any potentially lucrative acquisitions that could affect the future share value? To what extent must the share purchaser subordinate its own economic interests to protect the interests of the vendor?

A recent decision of the Supreme Court of Canada, Ponce v. Société d’investissements Rhéaume ltée, 2023 SCC 25, sheds light on these questions, holding that the duty of good faith under the Civil Code of Québec, C.C.Q.-1991 may require share purchasers to provide the vendors with the necessary information to make an informed decision about the nature of the transaction.

Though decided under the Québec Civil Code, the Court’s reasoning in Ponce will no doubt have implications for the contractual duty of good faith in Canada’s common law jurisdictions.

Plotters and Schemers

Ponce involved a successful series of companies in the insurance industry, consisting of two brokerage firms and a life insurance enterprise.

The vendor shareholders, through their companies, owned the majority of the shares in the three corporations (the “Majority Shareholders”).

The buyers were appointed presidents of the insurance group of companies in 2002 (the “Presidents”).  

Pursuant to their role, the Presidents entered into an agreement with the Majority Shareholders, which consisted of eight clauses (the “Presidents Agreement”). The Presidents Agreement governed the relationship between the parties at the material time.

In the Spring 2005, the Presidents were approached by a third party (the “Third Party”), which expressed an interest in acquiring the group of companies.  

By July of that year, the Presidents and the Third Party had entered into a covert agreement, called an “Undertaking of Confidentiality”, which, among other things, was intended to prevent the Third Party from dealing directly with the Majority Shareholders or their holding companies. 

The Presidents never disclosed any of its dealings with the Third Party, nor was the Undertaking of Confidentiality revealed to the Majority Shareholders.

Over the course of 2006, the Majority Shareholders sold their shareholder interests to the Presidents for a total amount of approximately $33 million. Months later, the Presidents resold their shares to the Third Party for approximately $74 million.

The Majority Shareholders commenced a lawsuit upon learning of the shareholder acquisition by the Third Party in a press release. 

The Supreme Court of Canada upheld the Québec Court of Appeal’s rulings that the Presidents had breached their duty of good faith to the Majority Shareholders. 

The Court awarded the Majority Shareholders approximately $11 million for their lost gain.

In reaching the conclusion that the Presidents had breached their contractual duty of good faith, the Court made a number of observations about the scope of this obligation in commercial agreements:

1. The Duty of Good Faith May Include a Positive Obligation to Inform

The Court rejected the Presidents’ argument that they did not owe a good faith duty that would require them to inform the Majority Shareholders of the Third Party acquisition.

In the Presidents’ view, that would elevate the contractual duty of good faith to a fiduciary-like obligation – one that is contrary to commercial reasonableness.

In ruling against the Presidents, the Court noted that good faith necessarily implicates a duty of loyalty, which prohibits dishonest concealment for one’s own financial gain:

However, I agree with the trial judge that in this case the [Presidents] conducted themselves in a disloyal manner and lacked probity when they failed to disclose the interest expressed by [the Third Party] to the shareholders and when they signed the Undertaking of Confidentiality with [the Third Party] …

…

… the failure [of one of the Presidents] to convey to [one of the Majority Shareholders] the information he had at the time concerning the definite interest expressed by [the Third Party] amounted, at the very least, to dishonest concealment that was meant to mislead the shareholders …

…

In the context of this case, which involves a long-term business relationship, contractual good faith imposed a proactive duty to inform on the parties … remaining silent about [the Third Party’s] interest constituted disloyal conduct …

At common law, the functional equivalent to the civil duty recognized in Ponce above would be a violation of the obligation of honest contractual performance, which, under the Callow decision, supra, requires that contracting parties not lie, misrepresent or omit critical details regarding their dealings under the agreement.

2. Duty of Good Faith Does Not Require a Subordination of Economic Interests

The second key theme emerging from the Court’s decision in Ponce is that the requirement that parties not misrepresent a state of affairs in their contractual relationship does not require that each party subordinate their own legitimate interests to the opposing party.

The Court explained the requirement as follows:

[The Presidents] were, of course, not obliged to subordinate their interest to those of [the Majority Shareholders] in performing the Presidents’ Agreement, but they did have to look out for the interests of the [Majority Shareholders] in the legitimate pursuit of their own interests … The [Majority Shareholders] could therefore legitimately expect the [Presidents] to refrain from scheming in any way to enrich themselves at their expense.

The Court in the passage above is seeking to strike a balance between its requirement that parties perform their contractual duties honestly, while realizing that judicial overreach could harm freedom of contract and reasonable commercial dealings. 

Surely, shareholders do not expect that they have to undermine their own financial interests in favour of those of other shareholders in an acquisition. That being said, there is a minimum level of honest conduct expected of all parties to an agreement in Canada.  

Whether adhering to that level of honesty amounts to the subordination of one’s own commercial interests is effectively a question of fact, depending on the context.

How Shareholders Behave Matters

Ponce provides significant guidance in how shareholders should conduct themselves, particularly before a potential sale or acquisition.

Shareholders not only have a duty to act honestly, but they may have a positive duty to inform the other shareholders about circumstances that could alter the value of their shares post-closing. 

The harm Ponce seeks to remedy is the active concealment of material facts that can affect the other shareholder’s financial interests. In many ways, this is not a novel concept – for decades, Canadian Courts have held parties liable for failing to disclose potential share acquisitions by means of the oppression remedy.

What Ponce apparently provides is yet another avenue to attack this dishonest concealment – this time, by way of breach of contract.

Marco P. Falco is a partner in the Litigation Department at Torkin Manes LLP. You may contact Marco for advice concerning your shareholder agreement at mfalco@torkinmanes.com. Please note that a conflict search will be conducted before your matter is discussed.