November 2017
PFD | Business

How important is corporate formality in business relationships?

By Francis Chaussé Lawyer, Shane Goldman Lawyer

A recent decision by the Supreme Court in Mennillo v. Intramodal inc. (2016 SCCC 51) (hereinafter "Mennillo") raises the issue of formality in corporate law. Canada's highest court ruled that failing to meet the criteria stated in the Canada Business Corporations Act (the "Act") does not automatically give rise to a claim for oppression.

However, we are of the opinion that we should keep our pens handy and continue our formalist habits. First, we will revisit the facts in the case.  

The Mennillo ruling concerns an application for an oppression remedy pursuant to section 241 of the Act.

Intramodal inc. is a road transportation company founded by two men: Mr. Rosati, who was issued 51% of the shares and Mr. Mennillo, who was issued 49%. The two shareholders also sat on the board of directors. Mr. Rosati was more involved on the operations side, while Mr. Mennillo was more involved in the financial aspects of their commercial endeavour.

From the outset, both failed to observe the letter of the law. The resolutions pertaining to the notices of the subscription were signed by only one of the administrators, the shares were not paid to the company's treasury, Mr. Mennillo's shares certificate was not signed, the advances of money were not documented, the disputed transfer of shares was not signed by Mr. Mennillo and so on.

The evidence demonstrated that, after expressing his dissatisfaction with the company's performance, Mr. Mennillo asked to be considered a creditor since he no longer wanted to carry the risk. The shareholders then negotiated and agreed that Mr. Rosati would purchase Mr. Mennillo's shares. However, the measures they took did not comply with the procedures imposed by the Act.

It is important to note the legal precedents related to oppression remedies that the Supreme Court applies in such cases: those set out in the ruling in BCE inc. v. 1976 Debentureholders (2008 SCC 69). These criteria are clearly summarized by the Supreme Court in Mennillo:

[9] There are two elements of an oppression claim. The claimant must first identify the expectations that he or she claims have been violated and establish that the expectations were reasonably held. Then the claimant must show that those reasonable expectations were violated by conduct falling within the statutory terms, that is, conduct that was oppressive, unfairly prejudicial to or unfairly disregarding of the interests of any security holder.

In the Mennillo ruling, one of the most significant findings by the majority is that Mr. Mennillo no longer wanted to be a shareholder and no longer wanted to be considered as one. It was for these reasons that the shares were transferred to Mr. Rosati.

Immediately following this factual conclusion, the majority indicated that Mr. Mennillo "could have no reasonable expectation of being treated as a shareholder." (57)

While there may be reasonable expectations on a shareholder's part with respect to compliance with the formalities imposed by the Act, failure to comply does not, on its own, constitute oppression. In the case at hand, the corporation carried out Mr. Mennillo's expectations in a manner consistent with its standard practices: without strictly complying with the formalities of the Act.

That being said, there are several formalities stipulated in the Act and great caution is required. Indeed, the Court states that failure to observe an important formality may give rise to a judicial declaration of nullity, provided that the action was filed within the limitation period (in Mennillo, this would have been the case with regard to the fact that there was no endorsement).

Moreover, several reasons strongly support compliance with corporate formalities, including lower risks related to tax audits, disputes regarding corporate operations (contracts, financing, etc.) and litigation between shareholders and the avoidance of costs related to lengthy updates to the company's records should the business be sold.

The majority judges underlined this fact by mentioning: "many of the legal difficulties in this case have arisen as a result of the virtually complete lack of formality that accompanied the parties' business dealings." In other words, if the company had complied with the formalities set out in the Act, the parties would have likely avoided the costs incurred by a case brought as far as the Supreme Court.  

If you have any questions on the ruling or if you would like one of our experts to review your company's books, do not hesitate to contact us.