In a recent decision, the Quebec Court of Appeal unanimously overturned a Quebec Superior Court judgment, thereby dismissing an oppression remedy complaint under the Canada Business Corporations Act (the CBCA) against the directors of an early-stage technology company that had received a venture capital investment as well as the investee company itself. In so ruling, the appellate court enunciated the principle that the standard of care to which the directors and officers of an early-stage company (particularly where some or all of the directors are also representatives of the venture capital investor) should be held in the context of an oppression remedy claim is not necessarily as rigorous a standard as that to which the directors and officers of a more mature and financially secure corporation should be held. In addition, the Court of Appeal granted the status of oppression remedy complainant to one of the plaintiffs who was not a shareholder but rather an optionholder of the defendant corporation on the basis that the defendants had in fact dealt with the optionholder as if she were the beneficial holder of the underlying shares.
The facts in Garage Technology Ventures Canada, S.E.C. v. Léger et al.1 may be summarized as follows. One of the complainants, Ms. Leger (Léger), founded and operated for several years Impact I.S. Inc. (Impact), a company that developed software marketed to interior designers and owned its intellectual property rights. Léger approached a venture capital fund, Garage Technology Ventures Canada (Garage), for the purpose of negotiating a venture capital investment in Impact to finance the development and commercialization of a new piece of software. Garage extended a $200,000 bridge loan to Impact, with the loan having been secured by a movable hypothec (or security interest) on the assets of Impact, including its intellectual property.
Relatively shortly before completion of the scheduled equity investment by Garage in Impact, the principals of Garage insisted that instead of Garage investing directly in Impact, which was heavily indebted and in a precarious financial situation at the time, and in anticipation of a potential public listing, Garage would capitalize and invest in a newly formed corporation under the CBCA, Média Lure inc. (Lure), which would in turn acquire ownership of all of Impact’s assets through the exercise of the secured lender’s rights under the hypothec that had been granted by Impact for an additional $500,000 bridge loan. The plaintiff Léger agreed, albeit reluctantly, to the change in deal structure. The terms of Garage’s investment in Lure also provided that Léger would not initially be a shareholder of Lure but was instead granted an option to acquire a third of Lure’s equity for an aggregate nominal consideration of $1.00. Until such time as Léger exercised her option to acquire shares of Lure, the board of directors was composed exclusively of the two principals of Garage.
Several months after Lure completed the acquisition of Impact’s assets and Garage’s equity investment, the principals of Garage decided to shut down the business operated by Lure in light of its continued losses and poor financial condition. Lure ultimately dismissed virtually all of its employees, including Léger, and ceased carrying on business. At such time, Léger had not yet exercised her option and thus never became a shareholder of Lure.
The plaintiffs (Léger and her holding company) instituted an oppression remedy claim under Section 241 of the CBCA against Lure and a number of other defendants, including the two principals of Garage who were also the sole directors of Lure, as well as Garage itself.
Superior Court decision
In first instance, the Quebec Superior Court ruled that even though Léger was not per se a shareholder of Lure, she should be granted standing as a “complainant” for the purpose of an oppression remedy proceeding under the CBCA as she was found to be the beneficial holder of the shares of Lure underlying her option. In essence, the Superior Court stated that, in the particular circumstances of the case and in light of the fact that the only formality to the plaintiff becoming a shareholder was the payment of a nominal sum of money, the plaintiff was, in fact, the beneficial holder of the underlying shares. The Superior Court also granted in full the plaintiff’s oppression remedy complaint on the basis that the defendants treated her as if they owed her no obligation whatsoever, acted as if they were the sole shareholders of Lure and unjustly disregarded her interests.
Court of Appeal decision
The Quebec Court of Appeal, while upholding the Superior Court’s decision to grant Léger standing as an oppression remedy complainant despite not having exercised her option, reversed the lower court’s decision and found that the first instance judge erred in having found that the defendants’ conduct was oppressive to or unfairly disregarded the interests of the plaintiff. Importantly, the Court of Appeal, in several passages, enunciated the principle that the scope of the obligations of the directors, officers and shareholders of an early-stage or start-up company must be evaluated in light of the highly speculative and tenuous nature of such companies and specifically stated that the duties and objectives of the directors and officers of an emerging start-up company (including the case where some or all of the directors are also representatives of the venture capital investor) should be to assure the short-term success or viability of the business, which in many instances will differ from the duties of directors and officers of more mature, established or financially secure companies that will be more long-term in nature.
The decision of Lure’s directors to “pull the plug” on the company after several months of additional losses, while somewhat quick, was found insufficient to evidence any oppressive scheme or conduct by the defendants but instead fell into the category of a decision or judgment of a business whose financing is proportionate to and must be judged in the light of the risks associated with early-stage companies. As stated by the Court of Appeal at para. 70 of its judgment: “The scope of the rights and obligations incumbent upon the directors, officers or shareholders of a development-stage company must be evaluated in the context of its operational realities and parameters. To do otherwise would risk imposing on such persons excessive duties that would not only go against both equitable principles in general but also the objective of the statute, which is to remedy an injustice and not to create a new injustice.” [translation]
By applying a measure of judgment, discretion and subtlety to the interpretation of directors’ and officers’ (and even shareholders’) duties in the context of early-stage, start-up and speculative companies, the Quebec Court of Appeal’s decision in Garage should provide a measure of comfort to venture capital investors and the directors and officers of investee companies, including independent directors, that when it comes to being judged on whether one has acquitted one’s standard and duty of care, the courts should abandon a “one-size-fits-all” approach in favour of a more flexible standard that is proportionate to the development stage, risk profile and investment horizon of the company in question.