Rutherford v Candor Engineering, 2017 ABQB 423

Court of Queen’s Bench of Alberta Citation: Rutherford v Candor Engineering

(2007) Inc, 2017 ABQB 423 Date: 20170705 Docket: 1401 09699 Registry: Calgary Between: Martin Rutherford Plaintiff - and - Candor Engineering

(2007) Inc. and Frank Shewchuk Defendants Between: Candor Engineering

(2007) Inc. and Frank Shewchuk Plaintiffs by Counterclaim - and - Martin Rutherford and 937836 Alberta Ltd. and Ice Automation Ltd. Defendants by Counterclaim

Corrected judgment: A corrigendum was issued on July 21, 2017; the corrections have been made to the text and the corrigendum is appended to this judgment. _______________________________________________________ Reasons for Judgment of J.T. Prowse , Q.C., Master in Chambers _______________________________________________________ [ 1 ] This is an application by the plaintiff Martin Rutherford for an order directing the defendants Candor Engineering

(2007) Inc. (“Candor”) and Frank Shewchuk to provide a further and better affidavit of records. [ 2 ] For the reasons which follow, I grant the application.

The pleadings [ 3 ] In his statement of claim Rutherford asserts that he was a shareholder of Candor and that there was an oral agreement that he be paid a percentage of the net profits of Candor based on his shareholdings. [ 4 ] Rutherford asserts that “in or about August of 2013, Rutherford learned that the financial statements provided to Rutherford for the 2011 and 2012 years significantly misstated the financial position of Candor.” He estimates that he was underpaid by not less than $2 million. Rutherford left Candor as a result of this.

He further says that subsequent to his departure, “Candor managed its accounting in such a way as to avoid paying Rutherford his proportionate share of the profits of Candor” [ 5 ] The remedies sought in the action include the appointment of an inspector and judgment in the amount of $2.0 million or such other amount as may be proven at trial. [ 6 ] The statement of defence asserts that the contract between the parties was a contract between Rutherford’s corporation, “937” and Candor, under which 937 agreed to provide the services of Rutherford to Candor. [ 7 ] The defendants deny that there was any agreement to share profits proportionate with shareholdings.

They further allege “In response to the whole of the Claim, and in specific response to paragraphs 7 and 8, the Defendants deny that Candor’s financial statements for 2011 or 2012, or at any time, misstated the financial position of Candor, significantly or at all.” They also allege that Candor has not changed its accounting procedures in order to pay Rutherford any more or less than the amount to which he is entitled. [ 8 ] Further, the defendants plead that “the false allegation that Candor’s financial statements were misstated in 2011 and 2012 is based on Rutherford’s misreading, misunderstanding and/or misinterpretation of documentation included within the misappropriated records”. [ 9 ] In its counterclaim, Candor asserts that Rutherford took or made copies of Candor’s financial records, which it refers to as ‘misappropriated records’. [ 10 ] In his Defense to Counterclaim, Rutherford admits that, prior his departure, he reviewed and made copies of financial records, but asserts that such records were properly and lawfully accessed under the authorization granted to him by Candor.

Rule 5.6 [ 11 ] The key rule is Rule 5.6 which requires each party to provide an affidavit of records disclosing all relevant and material records. [ 12 ] Rule 5.2 provides as follows: For the purposes of this Part, a question, record or information is relevant and material only if the answer to the question, or the record or information, could reasonably be expected (

a) to significantly help determine one or more of the issues raised in the pleadings, or (

b) to ascertain evidence that could reasonably be expected to significantly help determine one or more of the issues raised in the pleadings. Financial records

[ 13 ] On the face of it, where a plaintiff claims that he has not been paid his share of net profits of a defendant corporation, and alleges that the financial statements of the defendant corporation are inaccurate, the underlying financial records of the defendant are relevant and material. [ 14 ] A primary ground given by Candor for not producing further financial records is that to do so would be ‘onerous and disproportionate’. [ 15 ] Candor says that it has already produced thousands of documents, and faces producing thousands more.

It says that, in considering whether the additional documents are ‘relevant and material’, the Court needs to consider the unfair burden which would be imposed on Candor if it is required to produce these numerous additional documents. [ 16 ] The difficulty I have with Candor’s position is that the plaintiff has shown a willingness to agree to a less onerous procedure, but Candor has declined to participate. [ 17 ] In my view the ‘default’ position to working out a less onerous arrangement is not a denial of the plaintiff’s access to documents which are necessary to advance its case.

The default is to have Candor produce the documents by way of an affidavit of records. Alternative procedures [ 18 ] In earlier appearances the Court suggested that the plaintiff retain an expert witness (who would clearly be necessary for trial in any event) and make more focussed enquiries regarding documentation. The plaintiff took up this suggestion and, initially, Candor co- operated and engaged in a back and forth process of providing responses and documents. [ 19 ] Eventually Candor tired of the process and declined to carry on.

Candor’s position was that it had not agreed to enter into an interrogatory process, and that a number of the requests being pursued by the plaintiff (via the accountant retained by the plaintiff) were fishing expeditions. [ 20 ] Here are three examples of follow up enquires made by the plaintiff’s expert, including the rationale for that follow up enquiry: 1) Request: copies of contracts between Canfor and a list of related parties. Reason for request: the related parties are considered a high-risk area in the field of accounting.

They represent risk because it is common for related party transactions to have special terms and treatment to benefit the parties in ways that would not be considered ‘normal’ if the agreement was made with an independent third party. The related party transactions in Candor often involve the payment of expenses, which reduce the income base used in the allocation of earnings for minority interests.

Therefore, it is necessary to identify all related parties and understand the nature and assigned value of the transactions between them. 2) Request: the year-end accounting entries made/provided by the accountant during the year​end financial statement engagement for the years 2009 to 2015, inclusive. Reason for request: the accounting entries were requested because in the 2011 financial year, not all accounts in the financial statements reconcile to the general ledger.

For example, it appears that there was an additional accrual made for more than $500,000, which results in a decrease to income, which would reduce the income distribution to minority interests. Given that there is history of accounting entries, I am requesting all years at this point to prevent delay. 3) Request: Canfor’s accountant’s reconciliation for the 2012 opening balances from the 2014 audit. Reason for request: the reconciliation made restatements that changed the accumulated deficit to retained earnings, removed goodwill and changed the value of the preferred shares. These are unusual adjustments.

Changes to goodwill would be expected to be treated as a write-off, which would further increase a deficit. Changes to preferred shares are not expected unless they were dissolved. An audit was only performed for 2014. In 2015, the financial statements were presented as they were before the audit, without consideration of the changes made by the auditor.

Therefore, the support on how and why auditors’ made their adjustments, as well as the underlying detail of the goodwill and preferred shares accounts, are required to understand the financial statements. [ 21 ] The documents referenced in the three requests listed above are clearly relevant and material to the litigation, but they are currently not included in Canfor’s affidavit of records.

They should be. [ 22 ] If Canfor does not wish to proceed with the ‘interrogatory’ process, which was suggested to save time and expense, then the default position is to include all underlying financial documents in Canfor’s affidavit of records. [ 23 ] The ‘reasons for request’ outlined above justify the requests made. To me, Candor’s response is essentially ‘show me where there is a problem with the books and I will consider producing documents in that regard’. How can the plaintiff identify problems with the books without reviewing the underlying financial documents?

Questioning [ 24 ] Candor has suggested that it is ‘time to proceed to questioning’. [ 25 ] In my view, holding questioning without first producing the relevant documents would be a waste of time. There is a good reason why the Rules of Court contemplate document production first, followed by questioning. [ 26 ] Take, for example, request # 3 referred to above. Is the plaintiff to request, at examinations, without having seen them first, Candor’s accountant’s reconciliation for the 2012 opening balances from the 2014 audit? What are the chances of them being brought to

the questioning? And even if they were brought to the questioning, how would the plaintiff’s lawyer have the opportunity to prepare meaningful questions without advance notice? All that would result would be undertakings and continued questioning a later date. [ 27 ] Effectively Candor is suggesting that the plaintiff conduct questioning of Candor’s witness without having reviewed all relevant and material documents in advance. As stated, that would be a waste of time.

Narrowing the scope of production by reason of the plaintiff’s answers on cross-examination [ 28 ] Rutherford, the plaintiff, was cross-examined on his affidavit in support of his application for further production by the defendants.

He, as a non-accountant, was only able to able to point to one alleged flaw, which had to do with the amount of gross billings reflected in the financial statements. [ 29 ] The defendants attempt to narrow the scope of their document production based on this cross-examination. [ 30 ] Does the fact that the individual plaintiff, as a non-accountant, does not have the expertise to raise issues with the defendants’ books, examples of which are set out in paragraph 20 of these reasons, mean that the issues raised in those examples are not material and relevant?

I suggest not. [ 31 ] Issues of relevancy and materiality are determined by the pleadings, which I summarized at the outset of these reasons. Rule 5.2, which defines what is relevant and material, refers to the “the issues raised in the pleadings”. [ 32 ] Those pleadings encompass issues such as the examples set out in paragraph 20 of these reasons, and to date the defendants have not produced their records in that regard.

Conclusion [ 33 ] I suggest that the parties attempt, over the next 30 days, see if they can agree to an interrogatory and/or audit protocol which would obviate the need for further affidavits of records. [ 34 ] If the parties cannot agree to a protocol then I direct that on or before November 1, 2017, the defendants provide supplementary affidavits of records containing a listing of all of their financial records regarding the business and financial affairs of Candor. Heard on the 23 rd day of June, 2017. Dated at the City of Calgary, Alberta this 6 th day of July, 2017. J.T. Prowse, Q.C. M.C.C.Q.B.A.

Appearances: Mathew Farrell Guardian Law Group for the Plaintiff / Defendants by Counterclaim Aaron F. Rankin Bennett Jones LLP for the Defendants / Plaintiffs by Counterclaim

_______________________________________________________ Corrigendum of the Reasons for Judgment of J.T. Prowse, Q.C., Master in Chambers _______________________________________________________ The Style of Cause has been changed to reflect the Counterclaim and the Appearances.