Why Business Realities Matter in Corporate Oppression and Good Faith Claims

Commercial actions for oppression and breach of contract very much depend on the parties’ intentions.

When interpreting a contract, including whether the parties acted in good faith, Canadian Courts have as their main objective the determination of the parties’ intentions. This is a fact-specific inquiry:  Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53.

In bringing a claim for corporate oppression, a similar principle applies. The Courts look to the claimant’s “reasonable expectations” in deciding whether the opposing parties’ conduct rose to the level of oppression, unfair prejudice, or unfair disregard of a relevant interest: BCE Inc. v. 1976 Debentureholders, 2008 SCC 69.

There are, of course, fundamental differences between a good faith contractual action and one for commercial oppression – the latter being approached through the lens of equity, the former not.

These distinctions aside, both causes of action have as their goal the establishment of intentions or expectations on the part of the parties. Those intentions are inevitably determined by the business context in which the parties entered into their relationship.

In a recent decision of the Ontario Superior Court, Sin v. Kela Medical Inc., 2024 ONSC 6767, the Court dismissed a good faith and oppression remedy action, largely on the basis that the claimants’ intentions or expectations did not square with commercial reality.

Milestone #4

Sin involved the relationship between the claimant professional engineer and the defendant corporation, which was involved in medical health record technology.

The claimant joined the defendant in 2009 as their chief technology officer, and was a minority shareholder in the defendant corporation pursuant to an agreement between the claimant, the defendant corporation and the defendant corporation’s direct shareholder’s holding company (“HoldCo”). The claimant was responsible for developing a smart card intended to hold a patient’s medical records.

The direct shareholder of the defendant corporation, Mr. Kumar, then incorporated a separate company, KAI, in 2012, to provide installation and non-technical support services to physicians and clinics, using a new form of software.

In September, 2021, the claimant approached Mr. Kumar to request an equity interest in KAI. 

The father of the defendant Mr. Kumar, Dr. Kumar, then asked Mr. Kumar to explore the possibility of KAI becoming a wholly-owned subsidiary of the defendant corporation, to ensure that the claimant’s efforts remained focused on the defendant corporation and its goal of establishing a smart card for patient medical records.

Later that year, the defendant corporation entered into a loan agreement with Dr. Kumar’s company, Whitby Diagnostics, in which Whitby agreed to lend the defendant corporation approximately $1.2 million (the “Loan”).

Ultimately, to incentivize the claimant to deliver on his efforts vis-à-vis the defendant corporation, Mr. Kumar and the claimant entered into an agreement in 2013 (the “2013 Agreement”), which provided the claimant with a further interest in the defendant corporation and an equity stake in KAI, on reaching certain milestones.

One of the Milestones under the 2013 Agreement, known as Milestone 4, required that once the defendant corporation paid its outstanding debt, the claimant would acquire a 33% stake in all available classes of shares in KAI. If KAI could not grant the claimant this stake upon satisfaction of Milestone 4, the claimant would be entitled to a 33% profit share in the defendant corporation. 

The relationship between the parties deteriorated. The claimant resigned in July, 2014 and the defendant corporation ceased operating thereafter. The claimant went on to work for a competitor and was ultimately paid close to $500,000, but failed to deliver a marketable product to the defendants.

In 2019, a third party acquired all of KAI’s issued and outstanding shares, for approximately $10 million (the “Sale”).

The claimant sued the defendant corporation and Mr. Kumar, among others, for breach of contract and oppression, alleging that the defendants represented to him that KAI would be made a subsidiary of Kela, Milestone 4 could be fulfilled at any time, and 33% of the net proceeds of the share sale in KAI were to be issued to the claimant, subject to the defendant corporation’s debt obligations. Notably, KAI was not made a party to the action.

The Court dismissed the actions in breach of contract / good faith and oppression, among others, against the defendants.

In doing so, the Court placed considerable weight on the fact that neither cause of action was grounded in the commercial realities of the relationship between claimant and defendants.

1. Good Faith Does Not Allow the Court to Question Business Judgment vis-à-vis Non-Parties to the Contract

The Court in Sin recognized that the duty of good faith, which applies to all contracts in Canada, requires a party to act honestly and to exercise their contractual discretion reasonably, i.e., in accordance with the purposes for which the discretion was granted and not capriciously or arbitrarily:  Bhasin v. Hrynew, 2014 SCC 71;  Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7.

The claimant argued that the defendants breached this duty and exercised their contractual discretion unreasonably by not repaying the Loan from the proceeds of Sale. Specifically, because the purpose of Milestone 4 was to ensure that the Loan would be repaid prior to the claimant receiving his 33% interest in KAI, it was unreasonable that the Loan would not be repaid from the proceeds of the Sale.

The Court rejected this argument, holding that it could never have been the parties’ intention to have KAI pay off the defendant corporation’s debts in the Loan. 

Underlying the Court’s analysis is a concern not only that KAI was not a party to the 2013 Agreement or the action, but that good faith does not require Courts to question commercial judgment and cause one corporation, for example, to satisfy the debt obligations of another. This was simply not commercially reasonable:

In essence, the plaintiff is asking that KAI pay [the defendant corporation’s] debts out of the proceeds of sale of its shares. He also says that he is entitled to a 33% profit share in KAI. [The claimant] has provided no authority for the court to make the order sought or to make an order that affects a non-party. KAI is not a party to these proceedings. KAI and [the defendant corporation] are separate legal persons.

The defendant corporation acted in good faith and compensated the claimant for more than the benefits required of the milestones.  

In these circumstances, commercial reality could not impose a positive duty on a corporation to satisfy the debts of another, particularly where one of the corporations is a non-party to the contract.

 2. Oppression Remedies do not Protect Unrealistic Commercial Expectations

The claimant further argued that the defendants’ conduct was oppressive, such that he had a reasonable expectation that he would be paid accumulated dividends as a shareholder of the defendant corporation, that KAI would become a subsidiary of the defendant corporation (as allegedly represented), which would have protected his deferred 33% interest in KAI, that the defendants would have used the KAI Sale proceeds to pay the defendant corporation’s Loan, and that the defendants would have provided him with adequate disclosure of information relating to the achievement of Milestone 4.

The Court dismissed the oppression claim in its entirety, largely on the basis that none of the claimant’s alleged expectations aligned with the terms of the 2013 Agreement, nor with commercial reality.

The defendant corporation never reached a “point of profitability” because of its debts. Accordingly, no dividends were ever issued by the defendant corporation, and so the claimant had no right to accumulated dividends.

Further, the claimant’s reasonable expectations made “no commercial sense”. As stated above, there was no good reason that KAI would use the Sale proceeds to pay the debts of another company, the defendant corporation, thereby triggering one of the preconditions for Milestone 4.

All of the decisions made by the defendants appear to have had “valid commercial purposes”. The notion that KAI be made a subsidiary of the defendant corporation was abandoned on the advice of counsel and other tax professionals. There was no evidence of bad faith on the part of any of the defendant corporation’s directors.  Moreover, the claimant failed to accomplish his one task of bringing the smart card to market – despite having been compensated by the defendant corporation in monies and shares.

In the circumstances, there was an incongruity between the claimant’s expectations and general commercial practice.

Business Realities Matter

The Sin decision illustrates that, legal doctrine notwithstanding, the practical commercial realities of a transaction will determine the outcome of a breach of good faith or oppression claim.

Inevitably, when considering the parties’ conduct and their reasonable expectations, the Court’s analysis turns to business pragmatics, including such things as the profitability of the enterprise, the separate identity of corporations, the business advice given by legal and accounting professionals, and whether the directors were acting in the best interests of the business as a whole.

These considerations drive the legal thought-process. In the end, commercial litigation remedies very much depend on corporate practice and reality.

Marco P. Falco is a Partner in Torkin Manes Litigation & Dispute Resolution Group. You may contact Marco about your business agreement at mfalco@torkin.com. Note that a conflict search will need to be conducted before your matter can be discussed.