When Is A Corporation Not A Corporation? - Corporate Governance

The Ontario Superior Court of Justice (the "Court") in its recent decision in Yaiguaje v. Chevron Corporation has reaffirmed the nature of the legal relationship between a parent corporation and its subsidiary corporation. That relationship reflects fundamental principles of corporate law, as well as modern commercial relations.

Background

The Litigation

The plaintiffs in Yaiguaje v. Chevron Corporation represented approximately 30,000 Ecuadorean villagers who live in a region of Ecuador that suffered environmental pollution as the result of the activities of oil companies from the 1960s to 1990s. These plaintiffs were successful in litigation in Ecuador and obtained a judgement (the "Ecuadorean Judgement") of US$9.5 billion against Chevron Corporation ("Chevron").

Chevron refused to acknowledge or pay the Ecuadorean Judgement. Chevron has no assets in Ecuador. As a result, in 2012, the plaintiffs commenced an action before the Court for the recognition and enforcement of the Ecuadorean Judgement against Chevron, Chevron Canada Limited ("Chevron Canada") and another Chevron subsidiary.

In the Ontario action, the plaintiffs sought, among other things:

the Canadian equivalent of US$9.5 billion resulting from the Ecuadorean Judgement against Chevron;
a declaration that the shares of Chevron Canada were available to satisfy the Ecuadorean Judgement, should it be enforced in Ontario; and
the appointment of an equitable receiver over the shares and assets of Chevron Canada.

Chevron and Chevron Canada

Chevron is a Delaware public corporation with its head office in California. Its principal business is the holding of shares in subsidiary corporations and managing those investments. Chevron does not itself engage in the exploring, producing, refining or marketing of petroleum products; those activities are carried on by its many indirect subsidiaries.

Chevron has never been registered to carry on business in Ontario or anywhere else in Canada. With the exception of its interest in two Bermudian companies, all of Chevron's assets are owned and located in the United States. It files consolidated financial statements in accordance with applicable laws in the United States.

Chevron Canada is a seventh level, indirect subsidiary of Chevron, amalgamated under the Canada Business Corporations Act (the "CBCA"). Its major business activities involve petroleum and natural gas exploration in Canada. It has never carried on business in Ecuador and played no role in the events leading up to the Ecuadorean Judgement, nor had it any connection to the legal proceedings leading to the Ecuadorian Judgement. All of the shares of Chevron Canada are owned by Chevron Canada Capital Company, which was not a party to the proceedings before the Court.

Chevron and Chevron Canada have separate and independent boards of directors, and none of the Chevron directors or executive officers serves on the board or is involved in managing the operations of Chevron Canada.

The Law in Question

Under the CBCA, the statute governing Chevron Canada, a corporation has the capacity, and subject to the CBCA, the rights, powers and privileges of a natural person. As such, it is a legal entity distinct and separate from its shareholders. Chevron Canada relied upon this "corporate separateness" to argue that any judgement against Chevron (i.e., the Ecuadorean Judgement) was not also a judgement against Chevron Canada.

Attempts are sometimes made, usually by creditors, to get courts to look past the legal distinctiveness of a corporation in order to obtain control of the assets of the corporation, even though the corporation has no direct connection with the litigating party. This effort has been termed "piercing the corporate veil".

The Execution Act (Ontario) (the "Execution Act") provides that "the sheriff may seize and sell any equitable or other right, property, interest or equity of redemption in or in respect of any goods, chattels or personal property, including leasehold interests in any land of the execution debtor...". The plaintiffs contended that this language in the Execution Act entitles the sheriff to seize any property in which the judgement-debtor has a direct or indirect legal or beneficial interest, such as, in the context of the Ecuadorean Judgement, Chevron's indirect beneficial interest in Chevron Canada.

The Contending Positions of the Parties

The parties agreed that the Court had to decide two issues: (i) were the shares and assets of Chevron Canada available for execution and seizure pursuant to the Execution Act in order to satisfy the Ecuadorean Judgement; and (ii) if they were not, should Chevron Canada's "corporate veil" be "pierced" so that its shares and assets were available to satisfy the Ecuadorean Judgement?

The plaintiffs submitted that Chevron Canada is an asset of Chevron that was available for execution and seizure pursuant to the Execution Act in orderto satisfy the Ecuadorean Judgement. As an alternative argument, the plaintiffs submitted that the court should pierce Chevron Canada's corporate veil to make its shares and assets available to satisfy the Ecuadorean Judgement because of Chevron's effective control over Chevron Canada and the injustice that would result from applying the "corporate separateness" principle to Chevron in the circumstances of the case.

Chevron Canada submitted that the plaintiffs' claims against it should be dismissed because:

Chevron Canada was not a party to the Ecuadorean proceeding;
Chevron Canada was not a judgement-debtor under the Ecuadorean Judgement;
the plaintiffs did not allege any wrongdoing against Chevron Canada;
Chevron Canada is its own separate legal entity, distinct from Chevron, and therefore its shares and assets do not belong to Chevron; and
the plaintiffs' claim was barred by the legal principle of corporate separateness and that there was no basis to pierce Chevron Canada's corporate veil to make either its shares or assets available to satisfy the Ecuadorean Judgement.

The Decision of the Court

The Court decided that (i) Chevron Canada is not an asset of Chevron, and (ii) circumstances did not merit piercing the corporate veil of Chevron Canada.

Chevron Canada Not an Asset of Chevron

In ruling that Chevron Canada is not an asset of Chevron, the Court reiterated basic principles of corporate law, while interpreting the function of the Execution Act:

"Chevron Canada's incorporating statute, the CBCA, gives it all the rights, powers and privileges of a natural person...

Chevron Canada is not an asset of Chevron. It is a separate legal person. It is not an asset of any other person including its own parent, [Chevron Canada Capital Company]. The Supreme Court of Canada confirmed this in BCE Inc. v. 1976 Debentureholders, where the court stated, 'While the corporation is ongoing, shares confer no right to its underlying assets.'

The Execution Act, which is a procedural statute, does not create any rights in property but merely provides for the seizure and sale of property in which a judgement-debtor already has a right or interest. It does not establish a cause of action against Chevron Canada. Chevron Canada is not the judgement-debtor under the Ecuadorean judgement and, therefore, the Execution Act does not apply to it with respect to that judgement. The Execution Act does not give Chevron any right or interest, equitable or otherwise, in the shares or assets of Chevron Canada."

Based upon these principles, the Court held that Chevron has "no legally recognized interest in Chevron Canada's assets unless the corporate veil between the two companies is pierced."

Piercing the Corporate Veil

Before analysing whether the corporate veil between Chevron and Chevron Canada should be pierced, as the plaintiffs claimed was appropriate, the Court made the following observations about the "corporate separateness" of Chevron and Chevron Canada:

Chevron and Chevron Canada are separate legal entities with separate rights and obligations. The principle of corporate separateness has been recognized and respected in the common law since 1896.
The principle of corporate separateness applies equally to groups of companies such as Chevron's group of companies, of which Chevron Canada is a part.
The principle of corporate separateness provides that shareholders of a corporation are not liable for the obligations of the corporation. It also provides that the assets of the corporation are owned exclusively by the corporation, not the shareholders of the corporation. As a result, Chevron does not have any legal or equitable interest in the assets of Chevron Canada as an indirect shareholder of Chevron Canada.

As the principle of "corporate separateness" applies to Chevron and Chevron Canada, the Court held that for the plaintiffs to succeed (i.e., have the corporate veil between the two companies pierced) the plaintiffs had to prove:

that Chevron Canada was "completely controlled and dominated" by Chevron (which requires more than ownership) (the "Control Requirement"); and
that Chevron Canada was being used by Chevron "as a shield for fraudulent or improper conduct" (the "Improper Conduct Requirement"). Simply claiming that it was just and equitable to pierce the corporate veil was not enough.

The Court concluded that the plaintiffs had failed to satisfy the Control Requirement because, among other facts:

The management of Chevron Canada operates its business in a fashion which is separate and distinct from that of its parents up the Chevron corporate "family tree", subject to the direction of its own board of directors which does not contain any over-lapping members with the Chevron board or executive.
Chevron Canada employs, trains and directs the activities of its own professional, operational and administrative staff; it pays their salaries and benefits, and it provides workers' compensation coverage as required.
As part of a worldwide "family" of companies, Chevron Canada is subject to certain "family" budget reporting requirements and large capital expenditure approval processes, but it initiates its own plans and budgets, it funds its own day to day operations, and the capital expenditures made by it for the major Athabasca Oil Sands Project, Hibernia Project and Hebron Project were funded from its own operating revenues.
Chevron Canada is a fully capitalized corporation which funds its own day to day operations, without financial contributions from Chevron or any other Chevron entity.
Chevron Canada files its own tax returns and corporate statements.
Chevron files a consolidated set of financial statements because it is required to do so by the United States Securities and Exchange Commission and the Sarbanes-Oxley legislation.
The provision of guarantees by Chevron for Chevron Canada underscored their separate existence.

The Court also concluded that activities such as central review and approval for capital expenditures, cross guarantee of debt and payment of dividends did not, in and of themselves, demonstrate complete control and domination of a subsidiary by its parent.

With respect to the Improper Conduct Requirement, the Court observed that the plaintiffs had not even alleged that Chevron's corporate group structure was suspect:

"The plaintiffs do not allege that the corporate structure of which Chevron Canada is part was designed or used as an instrument of fraud or wrongdoing. In fact, they specifically plead that they 'do not allege any wrongdoing against Chevron Canada'. As such, they cannot establish wrongdoing akin to fraud in the corporate structure between Chevron and Chevron Canada. They therefore do not meet this fundamental condition of piercing Chevron Canada's corporate veil."

In conclusion, the Court declined to pierce the corporate veil between Chevron and Chevron Canada:

" ... applicable jurisprudence makes it clear that even if the plaintiffs were able to establish that Chevron exercises total effective control over Chevron Canada, which they have not done, this would not satisfy the test for ignoring Chevron Canada's corporate separateness and piercing its corporate veil. There would also have to be wrongdoing "akin to fraud" to meet the test. There is no such wrongdoing in this case."

Conclusion

In Yaiguaje v. Chevron Corporation the Court reaffirmed the legal principle of the "separateness" of a corporation from its shareholders. As previously stated, that relationship is a fundamental aspect of corporate law, as well as modern commercial relations.

The distinction of a corporation from its shareholders defines a corporation's relationship with those with whom it carries on business and otherwise affects. The Court agreed with the following submission by Chevron:

"If the Plaintiff's position regarding the effect of section 18(1) of the Execution Act is accepted, the assets of Ontario subsidiaries of both domestic and foreign companies would automatically and always be subject to execution orders to satisfy judgements against their parent companies. In fact, the debts of individual shareholders could be enforced against the assets of any Ontario company. This result is not only contrary to law, it would have startling and stark consequences for Ontario's businesses and their ability to attract investment."

For those structuring the operations of companies in corporate group structures, the Court's decision offers comfort that the exercise is worthwhile. The organization of assets and businesses in a corporate group structure can be undertaken for a variety of legitimate reasons. If this appropriate structuring also takes place in the absence of litigation or the threat of litigation, Yaiguaje v. Chevron Corporation predicts that a creditor will only have recourse against the corporation in the corporate group directly involved in its dispute, and not against any of its affiliated companies.

The Court's decision, paradoxically, might also have negative consequences for shareholders in situations where they wish to exert their influence over a corporation's affairs.

For example, under the CBCA and similar Canadian corporate law statutes, the sale, lease or exchange of "all or substantially all" of the property of a corporation other than in the ordinary course of business of the corporation requires the approval of the corporation's shareholders by special resolution. If a parent corporation has placed an intermediary holding company between it and an operating subsidiary (like Chevron was separated from Chevron Canada), the parent could argue that only the approval of the intermediary holding company (which is controlled by the parent) is required for the sale, lease or exchange of the property of the operating company, rather than the approval of the shareholders of the parent company, because it is inappropriate (according to Yaiguaje v. Chevron Corporation) to characterize the property of the operating subsidiary as the property of the parent. This could be significant if the shareholders of the parent do not approve of the sale, lease or exchange of the operating subsidiary's property. If those shareholders tried to contest the transaction, the parent could argue that Yaiguaje v. Chevron Corporation mandates that those shareholders can only vote to approve a transaction involving the parent's property, not a transaction involving the property of its subsidiaries.

Significant asset sale, lease or exchange transactions are common. The ability to frustrate the exercise of shareholder approval of these transactions because of the structure of the corporate group is a significant potential constriction of shareholder rights. Interestingly, the Delaware corporate statute has been amended to specifically give shareholders of a parent corporation the right to approve a transaction involving a subsidiary. To date, Canadian corporate statutes have not been similarly amended.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Canada: When Is A Corporation Not A Corporation?