When should a successor company be forced to pay an advance on legal fees to predecessor shareholders whom the successor company is suing? The recent motion decision in Noranco v MidOcean Partners III1 might give pause to successor companies considering legal action against the selling shareholders who may be indemnified, under certain circumstances.
Background: In 2015, the shareholders (both institutional and individual) of Noranco Inc. ("Old Noranco") sold their shares to a corporation that later amalgamated with Old Noranco. The resulting company was also called Noranco Inc. ("New Noranco").
In April 2017, New Noranco sued, among others, the individual shareholders — who were also former directors and officers— of Old Noranco for damages caused by misrepresentations in the financial statements that the plaintiff relied upon in making its purchase. New Noranco claimed that it paid too much for the business as a result.
New Noranco claimed against the individual shareholder defendants as sellers who breached their contractual obligations under the share purchase agreement. New Noranco also claimed against the shareholder defendants for unjust enrichment and for breach of the duty of good faith concerning the same financial misrepresentations.
The Motion: The issue on the motion was whether the individual defendants were entitled to advances for their legal fees from the plaintiff New Noranco as part of an indemnity owed to them.
The individual defendants relied upon indemnification rights contained in Old Noranco's corporate by-laws, the share purchase agreement between Old Noranco and the purchaser, a unanimous shareholder agreement among the shareholders of Old Noranco, bilateral agreements between individual defendants and Old Noranco, and the indemnity provisions of Ontario Business Corporations Act.2
New Noranco argued that the individual defendants had not met the conditions required for advancement of their legal expenses, claiming that the indemnities only covered the acts or omissions of directors and officers. Old Noranco had sued the individual defendants in their capacities as shareholders, and shareholders did not qualify for indemnification.
However, the motion judge, Justice Myers, noted that the New Noranco claim against the individual defendants was so broad that it "implicate[d] directly the conduct of the individual defendants in their fiduciary capacities."3 He concluded, "[t]he question of whether they would have, should have, or could have disclosed the information to the purchaser under the [share purchase agreement] will necessarily involve a consideration of what they were entitled to do as fiduciaries – as officers and directors – owing, at the same time, duties to Old Noranco to act in its best interest."4
Accordingly, Justice Myers found that the individuals defendants — even though they were sued as shareholders of Old Noranco — were entitled to advances from the plaintiff for their reasonable legal fees and disbursements incurred defending this action. He did so because the plaintiff's broad claim was aimed at the shareholders, essentially, for failing to discharge certain fiduciary duties. His Honour also found that the plaintiff had failed to establish a strong prima facie case that the director or officer acted with mala fides towards the corporation (which, if found, may disentitle the director or officer to fee advancement under indemnity agreements or corporate by-laws).
The Takeaway: Successor companies should think carefully about claims against former directors and officers. If a successor company attempts to avoid fee advancement provisions for directors and officers by suing only the shareholder (but who also happens to be a director or officer), it may fail. The nature of the successor's claim against the individual defendants qua shareholders instead of qua directors and officers in this case could not avoid these obligations. And now, ironically, the plaintiff is subsidizing their defences.
Footnotes
1 2019 ONSC 1173, [Noranco].
2 R.S.O. 1990, c., B. 16 (the "OBCA").
3 Noranco, para. 50.
4 Noranco, para. 52.
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