ONTARIO – Company – Failure to document an agreement that equity contributions were in fact a loan is fatal. There must be an agreement or meeting of the minds. A minority shareholder is entitled to audited financial statements unless the shareholder has waived his or her right to statements.
Darvish-Kazem v Pazkaz Enterprises Inc.et al.
2022 ONSC 1667 (April 2022)
ONSC J. Morgan
The Applicant Darvish-Kazem (“DK”) is a 40% shareholder of the Respondent Pazkaz Enterprises Inc.(“Pazkaz”), a holding company. The Respondent Michael Pazaratz (“Pazaratz”) owns the balance of the Pazkaz shares. Pazkaz owns 40% of Rave Inc. (“Rave”) a start-up software company. The balance of the Rave shares are owned by Pazaratz, Rave employees and Cooper.
DK claims his shareholder interests have been unfairly prejudiced or disregarded pursuant to s. 248 of the Ontario Business Corporations Act, RSO 1990, c. B.16. (“OBCA”) by the issuance of shares to new investors in Rave. There is no Pazkaz shareholders agreement. There is a loan agreement which reflects that the contributions of DK and Pazaratz would be reflected on the books as shareholder loans and that no further shares would be issued in Pazkaz until the shareholder loans were repaid.
DK advised Pazaratz in 2016 he was no longer interested in funding Pazkan. The investments of DK ($1,058,103.50) and Pazaratz ($1,582,791.61) were advanced to Rave to operate.
In 2017, Rave was on the verge of bankruptcy. Pazaratz injected $150,000 to Pazkaz to allow Rave to continue operations. DK refused to contribute any funds into the company.(para.9) Thereafter, DK was removed as an officer and director of Pazkaz.
Rave required further funding. Pazartz’s mother, Cooper agreed to invest $1,621,000.00 into Rave. In April 2017, DK was notified of Cooper’s willingness to invest in Rave and that shares in Rave would be issued to Cooper for her investment.(para.11) DK was also offered an opportunity to purchase shares in Rave, which he declined. Cooper offered $30,000 per Rave share based on a $3 million valuation of Rave. The valuation benefitted DK because Rave was losing money each month at that point.(para. 12)
At the same time, Pazaratz also notified DK that he would have Rave issue Pazaratz shares in lieu of salary given that he had worked full time for Rave since 2013 without being paid a salary.(para.13)
- Did the issuance of shares in Rave to Cooper and Pazaratz dilute DK’s interest in Pazkan and Rave and did the dilution amount to oppression?
- Is DK entitled to audited financial statements?
1a) Morgan J. found that although the issuance of Rave shares to Cooper and Pazaratz diluted DK’s interests in both companies, the dilution was not improper because shares in Rave were only issued to those who invested money or labour to the business. (para.17) DK retained his 40% interest in Pazkaz and Pazaratz retained his 60% interest. (paras. 18 & 19)
1b) Morgan J rejected DK’s submission that the dilution of his shares amounted to oppression pursuant to s. 248 of the OBCA. Specifically, Morgan J. held that DK’s expectations that advances to Rave should be characterised as shareholder loans and that Rave advances were loans to Pazkaz, were not reasonable expectations. (paras. 22 & 23). The loan agreement between DK and Pazaratz related to Pazkaz only. There was no similar documentation or loan agreement for Rave. (para.24)
Morgan J held: “I find that Darvish-Kazem’s allegation that Pazkaz’s equity investment should have been transformed into a loan might reflect his own desire but does not reflect a meeting of the minds with Pazaratz or the corporate will of Rave.” (para. 24)
Morgan J distinguished Flatley v. Algy Corp., 2000 CanLII 22783 (SCJ) from this case. In Flatley, the failure to document shareholder loans was accompanied by allegations of misappropriation of funds and unaccounted for corporate payments, which amounted to oppressive conduct. In Rave, the company is not profitable, there is no allegation of misappropriation of funds and no shareholders of Rave have received any loan repayments or dividends. ( paras.26 & 27) The other allegations are absent.
It is well established that not every unmet, subjective expectation of a shareholder will give rise to a claim of oppression. There must be unfair prejudice or disregard of the minority rights as set out in BCE Inc. v. 1976 Debentureholders, 2008 SCC 69 (CanLII). (para.29). In order to establish oppression, the conduct must be oppressive, unfairly prejudicial or unfairly disregard the minority’s interest. Morgan J . did not find the issuance of Rave shares to Cooper and Pazaratz for money invested or labour constituted oppressive conduct. (para.29)
2) Morgan J. held that DK was entitled to audited financial statements of both companies, as they are required under the OBCA. Morgan J, referred to McInerney v. RJM Holdings Limited, 2019 ONSC 7179, at para 857, in which the court stated “ “[A] shareholder’s right to financial information or material concerning the corporation (including audited financial statements) is a clear and mandatory one that is prescribed by the OBCAand vested personally in the shareholder”. (para.29).
As Morgan J. noted, the parties could have negotiated a shareholders’ agreement or a shareholders’ resolution that would exempt the parties from the audited statements requirement but they did not. DK, as a direct shareholder of Pazkaz and an indirect shareholder of Rave, was entitled to audited financial statements for both companies.(para.33)