Financial Hardship is Irrelevant, Says B.C. Court of Appeal

In a decision released on January 29, 2014, the B.C. Court of Appeal ruled that companies incorporated under the Canada Business Corporations Act must, by operation of law, appoint an auditor, and thereafter produce annual audited financial statements. The Court has no discretion in this respect, and the particular financial circumstances of the company are irrelevant.

The decision of the B.C. Court of Appeal in Li v Global Chinese Press Inc is not particularly revolutionary – lower courts in Ontario ruled in exactly this same way as recently as 2007. But it is the first appellate case in Canada standing for the proposition that shareholders have an absolute right to an auditor and audited financial statements, and therefore it is a noteworthy case.

The CBCA Provisions

Section 162 of the CBCA states in mandatory terms (“shall”) that shareholders will appoint auditors annually:

162. (1) Subject to section 163, shareholders of a corporation shall, by ordinary resolution, at the first annual meeting of shareholders and at each succeeding annual meeting, appoint an auditor to hold office until the close of the next annual meeting.

(2) An auditor appointed under section 104 is eligible for appointment under subsection (1).

(3) Notwithstanding subsection (1), if an auditor is not appointed at a meeting of shareholders, the incumbent auditor continues in office until a successor is appointed.

(4) The remuneration of an auditor may be fixed by ordinary resolution of the shareholders or, if not so fixed, may be fixed by the directors.

The only way to avoid appointing an auditor at an annual meeting is by shareholder resolution: see section 163. Under the CBCA, such a resolution had to be passed unanimously by the shareholders, and such dispensation can only be made by companies that are not “distributing corporations” (i.e., in general, only private companies can rely on this provision).

Section 155 of the CBCA, relating to annual meetings of shareholders, also speaks in mandatory terms. It says that the directors of a corporation “shall” place before shareholders at every annual meeting, comparative financial statements, “the report of the auditor, if any”, and any further information respecting the financial position of the corporation required by the corporate bylaws and related constating documents of the corporation.

“If Any”?

As noted above, the directors of a company are required to produce to shareholders the report of the auditor, “if any”. This led the respondent company, Global Chinese Press Inc. to argue that the requirement to produce audited financial results was discretionary – sometimes there would be audited financial statements, sometimes there would be none: it is all up to the business judgment of the directors.

That was argued in Ontario in Merrill v Afab Security, Chrisger Systems Inc, without success. There, Justice R. Smith found:

The fact that section 155(1)(b) of the CBCA states the directors are to place before the shareholders at every annual meeting, the report of the auditor, if any, does not remove the requirement for the shareholders appoint an auditor at the annual meeting as set out in s. 162 of the CBCA. The use of the words “if any” in s. 155(b), would apply to the situation where all of the shareholders consented to dispense with the appointment of an auditor, pursuant to s. 163 of the CBCA and therefore a report of the auditor would not be one of the documents that was required to be placed before the shareholders in this situation. This interpretation is consistent with the two possibilities, firstly the requirement for production of audited financial statements and a report of the auditor where all of the shareholders have not waived the appointment of the auditor, and secondly the possibility that there is no auditor’s report, if all of the shareholders have consented to dispense with the requirement to appoint an auditor. As a result I do not find that the use of the words “if any” in s. 155(1)(b) removes the requirement for the shareholders to appoint an auditor at the annual meeting as set out in section 162 of the CBCA.

When the responding company argued this same point, the B.C. Court of Appeal in Li v Global Chinese agreed with Justice R. Smith’s position without reservation. It held:

I agree with that analysis. It is a complete answer to the company’s submission. The words “if any” found in s. 155(1)(b) only apply when the shareholders have by resolution consented to dispense with the appointment of an auditor.

Financial Position is Irrelevant

The Court also considered Global Chinese’s claim that its financial circumstances were such that it was unreasonably cost prohibitive to engage an auditor and obtain audited financial statements. This claim was similarly raised in Merrill. In both cases, the Court found that the financial circumstances of the company were simply irrelevant, given the lack of discretion conferred on the Court. The shareholders have a remedy in such a situation, which is to pass a resolution. As stated in Merrill, “The additional costs involved in requiring the appointment of an auditor is a reason that shareholders may choose to dispense with the requirement of having audited financial statements produced”. The B.C. Court of Appeal similarly found that financial circumstances were irrelevant in Li v Global Chinese.

The Bottom Line

The B.C. Court of Appeal set out the law as follows in concluding its judgment:

The CBCA sets out a comprehensive legislative scheme to provide financial information to shareholders. The scheme requires the appointment of an auditor and the production of audited financial statements unless the shareholders of a company unanimously determine otherwise. If a Company fails to comply with the statutory requirements, the legislation empowers the Court to appoint an auditor and order production of the required documentation.

While this case was decided under the CBCA, the principle would be equally applicable for companies incorporated under the Ontario Business Corporations Act. There, section 149 requires auditors to be appointed, and the only dispensation from such a requirement is if “all” of the shareholders of the (privately held) company agree to dispense with the requirements for the year following the resolution. This reasoning accords with the practical reality that a key element of the business conducted at an annual general meeting of shareholders is the consideration of the financial statements and auditors’ reports – indeed, Ontario courts have repeatedly allowed annual general meetings to be delayed pending the completion of an auditor’s report (see Re Imax Corp. (2007), 41 B.L.R. (4th) 289).

Of course, where a company is insolvent and has filed for insolvency protection, it will often not file audited financial statements during the insolvency proceedings, even where the company is a public company. The cash flow disclosure requirements of a company subject to the Companies’ Creditors Arrangement Act tend to be more current and detailed, at least as it relates to cash flow, than anything found in an audited financial statement.

Short of insolvency, the courts, now including the B.C. Court of Appeal, have stated somewhat categorically that if a company wishes to dispense with the auditor requirements, it can only do so by a unanimous shareholder resolution.