Superior Court clarifies that unmet shareholder expectations do not always amount to oppression
In Darvish-Kazem v Pazkaz Enterprises Inc, 2022 ONSC 1667, Justice E.M. Morgan of the Ontario Superior Court of Justice issued a friendly reminder pertaining to the OBCA’s s. 248 oppression remedy: without unfair prejudice or disregard of the minority’s rights, not every unmet, subjective expectation by a shareholder will give rise to such a claim.
Background
In 2013, two physicians, Michael Pazaratz (“Pazaratz”) and Saeed Darvish-Kazem (“Darvish-Kazem”), ventured out of the medical industry to start a software company, Rave Inc. (“Rave”). At the same time, they created a holding company, Pazkaz Enterprises inc. (“Pazkaz”), which was to own 40% of Rave’s shares.
Although Pazaratz and Darvish-Kazem never signed a Shareholders’ Agreement in relation to Pazkaz, in 2015, they did sign a Loan Resolution signaling that their respective ownership and financial contributions changed from 50-50 to 60-40. Pazaratz contributed $960,000 to Pazkaz, and Darvish-Kazem contributed $640,000, with both parties in agreement that no further shares would be issued until these shareholder loans were repaid in full. There was no mention of, or any restrictions on, Rave’s distribution of its own shares.
The trouble started in 2016, when Darvish-Kazem resumed the full-time practice of medicine and advised Pazaratz that he no longer wished to fund Pazkaz. By 2017, Rave was on the brink of bankruptcy, and in order to enable it to continue operations, Pazaratz contributed $150,000. He requested that Darvish-Kazem contribute his corresponding 40%, or $100,000, but not only did Darvish-Kazem refuse, he also had his lawyer send Pazaratz a letter which referred to the $150,000 contribution as “improper” because it was not approved by the Pazkaz board – aka himself and Pazaratz.
Given that Darvish-Kazem had ceased participating in the business, Pazaratz voted to remove him as a director and officer of both Pazkaz and Rave. Neither party contributed any further funds to Pazkaz. Rave, however, required funds to survive, and $1.6 million worth came from Pazaratz’s mother, Lynda Cooper, in return for shares. Pazaratz gave Darvish-Kazem advance notice of Cooper’s investment in April 2017 and advised him that she was prepared to pay $30,000/share based on a $3 million valuation of Rave. Pazaratz offered to sell shares of Rave to Darvish-Kazem at an equal price. He also advised that Rave would issue shares to Pazaratz in lieu of a salary equivalent to $300,000/year, given that he had worked for Rave fulltime since 2013, and had yet to accept a salary.
Share dilution
Darvish-Kazem argued that his interest in Pazkaz and Rave had been improperly diluted as a result of Pazaratz’s actions. Justice E.M. Morgan disagreed, finding that the evidence instead showed that both Pazkaz and Rave had issued shares commensurate with the respective shareholders’ investments. Yes, Darvish-Kazem’s interest in Rave had been diluted due to the issuance of new shares in Rave, but there was nothing improper about the way it was done. Rave had received a substantial infusion of money, and Darvish-Kazem retained an interest proportionate to what he paid for. Pazkaz remained a substantial shareholder of Rave, owning approximately 40% of its outstanding shares, with Darvish-Kazem retaining his 40% interest in Pazkaz, and Pazaratz retaining 60%.
Shareholder oppression
Darvish-Kazem’s next argument was that this share dilution constituted oppression of a minority shareholder under s. 248 of the OBCA. Once again, Justice E.M. Morgan disagreed, finding that the Loan Resolution agreed upon by Darvish-Kazem and Pazaratz did not once mention, nor did it apply to, Rave. It pertained to Pazkaz alone. The Court suggested that if Pazaratz and Darvish-Kazem had wanted to characterize Pazkaz’ equity contribution to Rave as a loan, they could have done so, but they did not, and now had to accept that reality.
Darvish-Kazem’s counsel relied on Flatley v Algy Corp, 2000 CanLII 22783 for the proposition that failure to record shareholder loans can be used as evidence that the offending shareholder has been treating the corporation as if he was the only investor. However, Flatley was distinguished given that in that case, the concern was that the lack of recording of shareholder loans meant it was impossible to determine whether other unexplained payments were being accounted for as repayments. In this case, there was no suggestion of misappropriation of funds or corporate payments unaccounted for. Given that Rave had no profits, neither Darvish-Kazem nor Pazaratz received any payments from it nor Pazkaz. There were no payments that could be characterized as shareholder loan repayments or dividends to shareholders.
Lastly, Darvish-Kazem sought an order compelling Pazkaz and Rave to produce audited financial statements, as they had only produced unaudited ones. While Justice E.M. Morgan recognized that there was no evidence of the books and records of the two companies being erroneous in any way, the matter remained that no audited financial statements had been done. He clarified that audited statements are more than just good practice, but rather required under the OBCA. Especially given the significant amount of distrust between the parties, Darvish-Kazem was entitled to a remedy under s. 248 of the OBCA to obtain audited financial statements.
The rest of Darvish-Kazem’s Application was dismissed.
