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Shareholder’s Loss

Posted on February 1, 2003 | Posted in Lawyers' Issues

Another law school quiz! Do you remember the rule in Foss v. Harbottle? It seems that not many lawyers remember it because, every so often, a lawyer takes a run at it. The latest run can be found in Medicare Healthcare Inc. v. Shoppers Drug Mart [2002] O.J. No. 3891 (C.A.).

What Is It

The rule is simple. A shareholder does not have a cause of action for a wrong done to a corporation. It is the flip side of the rule in Salomon v. Saloman (i.e. a shareholder cannot be held liable for the acts of its corporation).

Torts

The corporate shareholder operated a mail-order pharmacy business through subsidiary corporations. It alleged that the defendant devastated its business by way of nasty tactics. One demonstrated tactic was a false letter suggesting lack of safety in the subs’ businesses, published just before the shareholder’s initial public offering, an offering that was ultimately a dismal failure.

The shareholder sued for all sorts of economic torts: conspiracy, interference with contractual relations, misleading advertising, injurious falsehood, and unlawful infliction of economic harm. The subsidiaries did not join in the action.

The shareholder sold the subsidiaries two years after commencing the action for a substantial amount of money but claimed that they would have fetched much more were it not for the defendant’s actions.

The motions judge dismissed the action on a summary judgment motion and the shareholder appealed.

General Rule

The shareholder tried to bypass the general rule on a number of grounds.

It argued that the shareholder and the subs were really one economic entity and ought to be treated as such. The court agreed that there was one economic entity and noted that a court can pierce the corporate veil if it finds that the corporation is a sham or that there is fraud involved. However, the court also noted that there is a difference between economic reality and legal reality. Since the shareholder set up the legal reality, it could hardly argue that the court ought to pierce its own corporate veil.

The shareholder then argued that there was a principal-agent relationship between it and its subs, such that, as principal, it could sue the tortfeasor directly. The court noted that agency relates to contract and property, not tort.

The shareholder next argued that, because it was a secured creditor, it could sue in its own right. The court noted that the shareholder had used standard form GSAs and held that there was no evidence that the debts from the subs to the shareholder were not paid.

Finally, the shareholder argued that it had suffered personal damages. The court agreed that a shareholder could have its own cause of action against a wrongdoer if the shareholder could demonstrate that it had incurred damages in its personal capacity rather than as a derivative claim of the corporation. The question was whether this had happened.

Personal

The shareholder claimed that it had the following personal damages: loss of business opportunities, foregone cost of investments in its subs; loss in the value of its shares; and loss of goodwill.

The court stated that any loss of business opportunities were the losses of the subs, not the shareholder. Similarly, there was no evidence that the shareholder lost any money as a creditor. Finally, the court again stated that a shareholder in a corporation has no independent right of action based on diminution of share value due to damage to the corporation.

The claim for loss of goodwill, however, was different. Goodwill includes “reputation, position in the business community, client base, the expectation of public patronage and like considerations.” The court recognised the economic reality that the corporate shareholder was viewed as one and the same as the subs. Therefore, attacks against the subs were attacks against it and not only could the subs be hurt by the attacks, the shareholder could also be directly hurt by them. The court felt that the shareholder put forward enough evidence to show that the defendant “embarked upon a campaign to destroy it and its national mail-order business.” Accordingly, the court allowed the appeal as it related to the goodwill allegation.

Normal Situation

The Meditrust situation was unusual. A far more usual scenario is a shareholder claiming that a bank, by its allegedly improper actions, put its corporation out of business. The shareholder, who could be one of many, makes this allegation as part of a defence and counterclaim to an action by the bank on a guaranty. If the guaranty is limited to an amount that is substantially less than the money owed to the bank, the shareholder has problems. The corporation cannot advance this argument with much effect because it probably owes the bank a pot full of money and the argument, even if successful, may be of little avail to the corporation and, ultimately, the shareholder. However, if the shareholder can advance the claim individually, the shareholder will be much better off. Alas for the shareholder, this will not happen.

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