Adams v. Smith, 2013 BCSC 703

IN THE SUPREME COURT OF BRITISH COLUMBIA Citation: Adams v. Smith, 2013 BCSC 703 Date: 20130423 Docket: 11-4593 Registry: Victoria Between: Richard Bruce Adams and Paul Sutter Plaintiffs And Douglas Perry Smith, Edgar Malcolm Smith and George Phillip Smith Defendants Before: The Honourable Mr. Justice McKinnon Reasons for Judgment Counsel for Plaintiffs: James A. Hall Counsel for Defendants: Michael R. Mark Place and Date of Trial: Victoria, B.C. January 7-11, 14-18, 2013 Place and Date of Judgment: Victoria, B.C.

April 23, 2013 [ 1 ] The plaintiffs commenced an action in November 2011, for relief under several headings. At the commencement of trial, relief was limited to a claim of Breach of Contract. [ 2 ] In his opening submission, counsel for the plaintiffs said that he was seeking: a. An order that the plaintiffs are entitled to the issuance or transfer of shares representing, for each of the plaintiffs, 20% of the shareholdings of Natural Pastures Cheese Co. Ltd. b. An order affirming the agreement of the parties that the financial structure of Natural Pastures Cheese Co.

Ltd. is not encumbered by any indebtedness owed to the Defendants or Beaver Meadow Farms

(1971) Ltd. [ 3 ] The defendants deny that they are in breach of contract. They are willing to transfer to the plaintiffs the shares requested. However, they do not accept there was any “agreement” to forgive or forget money loaned to Natural Pastures Cheese Co. Ltd. and its successor corporate entity by Beaver Meadow Farms

(1971) Ltd . (“BMF”) and its various incarnations. Thus, they maintain, any transfer of shares must be subject to this indebtedness. HISTORY [ 4 ] I will refer to the plaintiffs as Adams and Sutter and the defendants as the Smith brothers. [ 5 ] Beaver Meadow Farms

(1971) Ltd. was incorporated on July 27, 1971. The Smith brothers acquired shares in the company in 1979. The company owned the farmland upon which the various operations were carried out. [ 6 ] Natural Pastures Cheese Company Ltd. (“Old Cheese Co.”) was the original cheese operation. It was incorporated on July 6, 2000. Its shares were ultimately equally held by the Smith brothers and Adams and Sutter. [ 7 ] On November 26, 1996, Beaver Meadow Farms (1996) was incorporated. Its only shareholders were the three Smith brothers. The company was responsible for the operational aspects of the farming business. [ 8 ] Beaver Meadow Farms

(1996) Ltd. amalgamated with Natural Pastures Cheese Co. Ltd. (Old Cheese Co.) on August 1, 1996 under the name Beaver Meadow Farms

(1996) Ltd. [ 9 ] On August 1, 2007, Beaver Meadow Farm Ltd.

(1996) Ltd. and Beaver Meadow Farms

(1971) Ltd. amalgamated under Beaver

Meadow Farms

(1971) Ltd. I will refer to the various Beaver Meadow Farms companies as BMF. [ 10 ] The Smith brothers operated a dairy farm with herd and milk quota in the Comox Valley of Vancouver Island. It was a third generation family operation that included other ventures such as cranberry, grain, and vegetable production. The farming operations were carried out under corporate ownership using the name BMF.

Over the years, the company used different descriptions when creating a new company or amalgamating with another company, but whatever corporate entity was created, it always contained the name, BMF. [ 11 ] In or about 1999, the Smith brothers became concerned about the ability to process their milk locally. Historically, milk from local farms was processed by a Cooperative which, unfortunately, got into financial difficulty and was sold to Dairyland which later became owned by Saputo of Montreal.

Saputo was contemplating closure of the processing plant in the Comox Valley and local farmers were concerned about the financial viability of processing their milk should that occur. [ 12 ] Adams was then operating a painting company in the Comox area and had done some work for a local cheese company, Comox Cheese. He became friends with the cheese maker, Ed Bestbier and the two of them talked about opening their own cheese operation.

To this end, they obtained information that they could source milk from BMF. [ 13 ] They approached Edgar Smith, who coincidentally had been in discussions with three other local farmers about finding a market source for their milk including the possibility of operating an artisanal cheese operation. The two groups formed a common cause to investigate the financial viability of a local cheese operation. Adams contacted a marketing company in Vancouver about obtaining funding and also investigated sales potential at Canada Safeway and other retail stores.

Edgar Smith arranged for the milk supply. [ 14 ] Ultimately, Natural Pastures Cheese Co. Ltd. (Old Cheese Co.) was incorporated and by July of 2000 shares were issued such that the Smith brothers (and several other farmers) had 51% of the issued shares while Adams and Bestbier had 49%. [ 15 ] The operations were conducted in a building in Courtenay owned by Norm Evans who later sold it to a company owned by the Smith brothers. Adams and Bestbier were active in the renovations as were the Smith brothers, particularly Phillip who had experience welding stainless steel.

Production began in 2000 with Bestbier as cheese maker and Adams as the sales and marketing person. [ 16 ] It soon became apparent that Mr. Bestbier was not capable of making the kind of cheese demanded by consumers. He left the company in 2001 and was replaced by Sutter. [ 17 ] Sutter is a certified cheese maker. He obtained certification in his native Switzerland where he was also employed as a cheese maker. He came to Canada in 1995 and worked for various cheese operations in the Okanagan and Kootenay regions.

Sometime in 2001 he learned of the search for a cheese maker at Natural Pastures and made a trip to Courtenay at the company’s invitation. [ 18 ] Negotiations between the parties resulted in Sutter working part-time for Natural Pastures while maintaining his other employment in Armstrong, BC. Eventually, he and the company agreed on terms that would permit him to become an equal shareholder after an eight-year period. In return for that promise, reduced to writing in 2003, he agreed to a “lower” hourly pay rate of $26 per hour.

He and his family moved to the Courtenay area in June of 2002, when he commenced full-time employment as cheese maker for the operation. [ 19 ] Despite some notable successes, including winning gold medals, the company suffered quality issues that at times required as much as a third of their production destroyed. Between 2002 and 2005 production quality was so inconsistent that the financial viability of the operation was in jeopardy.

THE FINANCIAL STRUCTURE [ 20 ] The financial aspects of the cheese operation covering the period from inception in 2000 to trial in 2013 suggests a very casual approach to accounting principles. It was admitted by the Smith brothers that some financial documents were incomplete and their efforts to re produce historical financial documents were often not much more than a guess. [ 21 ] According to Edgar and Douglas Smith it became clear by 2002 that the operation was losing money.

Edgar described his financial acumen at that time as a “farmer’s back pocket awareness.” [ 22 ] The initial primary lender to the cheese operation was the Bank of Montreal. Edgar testified that in 2002, Old Cheese Co. had exhausted its borrowing ability with the Bank of Montreal. These loans were guaranteed by the Smiths and Adams. Edgar testified that BMF was then advancing money to Old Cheese Co. “I would sign cheques and was aware that $100,000 to $400,000 was advanced at times.” [ 23 ] According to Edgar, he told all the shareholders about the various loans by BMF and all accepted that fact.

He said that shareholders were advised that the farm would continue to support Old Cheese Co and try to turn the business around and when it was able to meet its obligations, BMF would recover its loans. Adams would also recover $100,000, which all agreed was owing to him.

However, according to Edgar Smith it was understood that no one could be repaid until the cheese operation was financially viable. [ 24 ] Douglas Smith testified that he recalled discussions with his two brothers in 2002, to the effect that the cheese operation had exhausted its credit with the bank and unless an infusion of capital was obtained, the business would have to close. [ 25 ] Douglas testified to a meeting with Edgar and Phillip where they talked about BMF continuing to lend the operation money. He said, they added up the payables and “could see we were on the hook for a lot of money”.

Sutter had then commenced working for the operation and the brothers felt it would be prudent to continue advancing money to the operation through BMF to try to get it financially viable. [ 26 ] Douglas said he had a clear understanding that all amounts advanced by BMF would be repaid, they were not gifts. He said that

he would provide financial numbers at shareholders’ meetings and the defendants “should have been aware” of these figures. I pause to note that the defendants do not dispute that substantial sums were advanced by BMF but claim these advances were later “forgiven” [ 27 ] Douglas left the business to work in California between 2005 and 2008. It was on his return in 2008 that he became actively involved with BMF’s financial operations. He recreated BMF’s loans from historical documentation. It took him almost two years of investigation to come to some tentative conclusions about amounts owed.

While he conceded that he could not account for every penny, he thought his figures “are pretty close”. [ 28 ] In Exhibit #1 tab 52 he calculated that a total of $2,416,421.02 was advanced by BMF to the cheese operation over the years, less loan repayments of $240,000 for a balance due BMF of $2,176,421.02. This figure does not reflect the tax benefit of amalgamation but according to Douglas it is nevertheless “close”. [ 29 ] In 2005, the records indicate approximately $750,000 was owed to the Bank of Montreal and $595,966 to BMF.

In the Old Cheese Co. financial statement for the year ending 2010, Douglas Smith said that $2,086,000 was owed to BMF and $725,000 to the Bank of Montreal. [ 30 ] Douglas conceded that various financial records do not reflect sums advanced by BMF or Adams but explained that while the parties could not agree on precise figures, tax returns were required to be made, so some financial record had to be prepared. [ 31 ] There is no issue that BMF was the only borrowing source available for the cheese operation once its line of credit with the Bank of Montreal was exhausted.

Although the financial records are incomplete and there is some subjective

interpretation by the Smith brothers about advances made, there is no serious dispute that BMF advanced considerable funds, perhaps as much $2,400,000 between 2000 and 2011. [ 32 ] By 2005, Old Cheese Co had received considerable financial support from BMF (under its various corporate entities). The defendants allege it was in the vicinity of 1.3 million dollars. The plaintiffs claim no such assertions were reflected in the various accounting records until 2011 and suggest it was more on the order of $600,000. [ 33 ] I do not know how much money was advanced.

Douglas Smith provided accounting records gleaned from documentation he could find, but conceded that many of the corporate financial records for the early years have been lost. Based on his accounting, the amount advanced between 2001 and 2011 exceeds 2.45 million dollars. THE QUALITY CONTROL ISSUE [ 34 ] The plaintiffs devoted much trial time to quality issues, alleging the problem was with the milk supplied by BMF. However, all parties to the litigation agreed that these quality issues had nothing to do with the “agreement” upon which the lawsuit is based.

I remain puzzled as to why we spent so much time on a matter that was not connected to the issue requiring resolution. [ 35 ] In any event, no specific cause was ever established in respect to the quality problems. Various reports of experts in the field were filed, but apart from suggesting possible sources where the problem might arise, no definitive cause was ever established. The experts suggested some remedial action be taken in areas of possible contamination. These suggestions were followed. [ 36 ] The best that I can say about this diversion was that it was a matter of great concern to Adams.

In his testimony at trial he said he told Edgar he was considering a lawsuit against BMF. I assume that would not have been in his personal capacity but rather one commenced by Natural Pastures Cheese Co Ltd. over quality issues. That might have been a difficult process since Adams was a minority shareholder and it seems unlikely the Smith brothers would agree to suing themselves. In any event the Smith brothers consistently rejected suggestions that the problems came from BMF milk.

THE 2005 AGREEMENT [ 37 ] By 2005, not only were there financial concerns by all shareholders in respect to the continued viability of the cheese operation, there were challenges in respect to quality which was seriously impacting sales. [ 38 ] To deal with these financial concerns, the parties agreed BMF and Old Cheese Co. should be amalgamated to permit BMF to capture the losses of Old Cheese Co. Ltd. against gains from sale of herd and milk quota.

BMF’s financial advisors had suggested this route as a tax benefit strategy to BMF, because the losses could not otherwise be used and there was no detriment to Old Cheese Co. [ 39 ] A tax benefit valued at $241,000 was realized by BMF.

It was also agreed that the new operation would be operated for a year, after which its financial viability would be assessed. [ 40 ] On July 6, 2005, the parties held a “partners meeting” which was recorded by Adams in the following terms: July 6, 2005 Partners meeting for 2005 Edgar, Doug Phil and Paul Beaver Meadow Farms has outstanding loans of several hundred thousand dollars and BMF has guaranteed loans of about $900,000. Directors of Beaver Meadow Farms have decided it is unlikely they will receive their loans, interest or security from NP as state of NP is still insolvent after year 5.

Director of BM Farms wish to continue supporting NP for one more year in hopes (expectation) it will become solvent. In order to obtain some benefit for BM for the past 5 years directors and shareholders of NP (3 numbered companies) in discussion with directors of BM wish to amalgamate all companies and to continue operating NP cheese Co as a division of BM Farms.

This issue is brought to the annual GM for discussion. Motion by D. Smith that by July 31, 2005 the shares of NP Cheese Co will be amalgamated with BM Farms or there will be an intent to purchase with a 10% down deposit by July 31. Seconded by P.S. Motion carried. Doug Phil & Edgar ion favour Motion by E.S. to have Glen Moores review Memorandum of Understanding to Paul Sutter and make necessary changes. R.A. to re-type and forward [ 41 ] Neither Adams nor Sutter voted on the motion.

Adams testified that he wanted to “think about it some more.” Ultimately he accepted the amalgamation as did Sutter and both effected resignations and relinquishing of shares in Old Cheese Co. [ 42 ] Adams had by this time invested approximately $100,000 in the cheese operation. The Smith brothers do not dispute his claim. In fact, when Adams gave them a figure of $92,000, they suggested it be rounded up to $100,000 to account for interest and other contributions.

At trial, the Smith brothers accepted that Adams should be repaid, provided there was money available to make such payments but said that the Smith brothers (through BMF) should also be repaid. Both Adams and Sutter also accepted that, after amalgamation, all debts “justly owing” should be repaid.

The plaintiffs, however, dispute that BMF is owed anything, claiming that the effect of the amalgamation and discussion they had, particularly with Edgar Smith, extinguished such claims. [ 43 ] Although Adams and Sutter were obliged to surrender their shares in Old Cheese Co. and resign as directors, it was clearly understood by all shareholders that a new company would be created (New Cheese Co.) and eventually if/when that operation became viable, Adams and Sutter would be issued their shares and regain an equity position similar to that enjoyed in Old Cheese Co. [ 44 ] On August 1, 2005 the amalgamation of Old Cheese Co. and BMF

(1971) Ltd. was realized. On August 1, 2007 the Smith brothers also caused the amalgamation of BMF

(1996) Ltd. and BMF

(1971) Ltd. under the name of BMF 1971 Ltd. [ 45 ] Natural Pastures Cheese Co. Ltd. (“New Cheese Co.”) was incorporated in 2006 but did not begin operations until 2009. At that time it assumed operations as the corporate vehicle for the cheese operation. The Smith brothers are the sole shareholders. It is from this company that the plaintiffs seek issuance of their claimed shares. [ 46 ] The crux of this lawsuit rests with a determination as to what was agreed upon at a meeting attended by Edgar Smith and the two plaintiffs on August 4, 2006.

There is some dispute as to whether this meeting took place in July or August. Edgar has some notes suggesting it was July 7, 2006, however nothing turns on this issue. The purpose of the meeting seems to have been a review of the one year period (set out in the July 5, 2005 minutes), to assess the financial viability of New Cheese Co. [ 47 ] Once again, Mr.

Adams compiled minutes of this meeting which he recorded as follows: Edgar/Paul/Rick Aug 4/06 Need shareholders agreement Natural Farms owns buildings and trademarks 5 common shares - Paul’s in escrow till end of Dec 09 Amalgamation of farm and cheese co - able to write off all debts New company to start with no debts other than bank. We should get numbered accounts to avoid capital gains tax We will be five equal partners starting out without any major debt other than bank Rick Adams to receive his $100,000 first after payment of bank debts. Company to stand on it’s own Milk quota is part of N.P. Cheese.

In farms name - can be changed over - farm carrying the insurance. [ 48 ] The plaintiffs maintain these minutes, coupled with their evidence and the paucity of financial records in respect to alleged debts to BMF, collectively supports their claim that the defendants agreed that the result of amalgamation was to extinguish any claims by BMF for monies it advanced to the cheese operation. [ 49 ] The defendants reject that position as an absurdity, having no foundation in the evidence. They maintain that such a position makes no commercial sense and that the plaintiffs have deluded themselves on this point.

They do not dispute phrases such as “write- offs” were used but say that referred to the tax recovery expected from the amalgamation and did not refer to the write off of debt owing to BMF. CONCLUSION [ 50 ] I have concluded that the plaintiffs’ assertion that the defendants agreed to “cancel/forgive” the sums advanced by BMF to Old Cheese Co. has not been established and the plaintiffs’ claim for issuance of shares in New Cheese Co. clear of this obligation must be dismissed. [ 51 ] In reaching this conclusion, I must say that I have no idea how much is owed to BMF. That was not the focus of the trial, save

for establishing that considerable sums were owed. Even the plaintiffs conceded that considerable sums were owed to BMF at the time of the 2005 Agreement and they were “surprised” and “happy” to learn that debt whatever the amount) would be “wiped away” by amalgamation. There will have to be an accounting of these sums together with a determination as to whether the “write-offs” achieved by amalgamation are to be considered. [ 52 ] The issuance of shares to the plaintiffs was never in issue.

The issue was whether the shares would be subject to the debt due BMF, which by this judgment, I have held that they are. [ 53 ] Equity presumes a bargain, not a gift. The plaintiffs’ assertions of an agreement to forgive these debts simply makes no sense. Mr. Adams claimed that although he would be entitled to recover his $100,000 investment, the Smiths, through BMF, would not be entitled to the same consideration. [ 54 ] Mr.

Adams stated none of the funds advanced by BMF before amalgamation were “gifts”, and that it was his clear understanding of the 2005 Agreement that the cheese business would carry on operations and that if/when it became successful, both the defendants and the plaintiff Rick Adams would receive, in full, the funds due them. [ 55 ] Edgar Smith testified that at no time did he ever convey to Adams the notion that pre amalgamation debts owed to BMF by Old Cheese Co. would be “written off” or “forgiven”. [ 56 ] There is no evidence that Edgar Smith had the right to negotiate such a deal on behalf of his brothers.

In fact, the evidence, is to the contrary. Edgar Smith testified that he had no authority to make such a “deal”. His brothers testified that they would never have approved such a “deal”. Defendants’ counsel made the following submissions with which I agree: The 2005 agreement was entered into with several concrete and agreed upon principles: a. That Beaver Meadow Farms would continue its financial support of the cheese operation for a further year in the hope the cheese operation would become successful b.

That if and when the cheese operation again became successful the debts owed by the cheese operation both prior to, and after the amalgamation would be fully paid. c. That absent this agreement all parties were in danger of losing both their investments in the cheese operation, both financial and otherwise The agreement is plain. The parties amalgamated in an attempt to save the cheese operation. The intent and stated agreement of all the parties was that if the cheese operation was successful it would be bound by pre and post amalgamation debts accrued.

Debts owed to both the plaintiffs and the defendants. [ 57 ] In my view, Mr. Adams has seized upon words conveyed by Edgar Smith such as “write-offs” to fortify his somewhat tortured

interpretation of the August 4, 2006 meeting between himself, Paul Sutter and Edgar Smith. There is no evidence, however, of any “meeting of the minds” in respect to a forgiveness of debt. [ 58 ] Edgar testified that at no time during the meeting did he use words or convey a message that pre amalgamation debt to BMF would be “gone”. He testified, “No I don’t even think the topic came up. There was no comment by me that almost two million dollars owing to BMF would be forgiven or paid by tax benefits”. [ 59 ] The minutes, recorded by Mr.

Adams do state: “new company to start with no debts other than bank....we will be five equal partners starting out without any major debt other than bank.....Rick Adams to receive his $100,000 first after payment of bank debt”. However, these minutes represent only what Mr. Adams believed was stated they do not establish any agreement by the Smith brothers that they intended to forgive the debt to BMF. [ 60 ] Edgar then stated: I have never at any time taken the position that the debt to BMF was “paid”. It just makes no sense that I would say such a thing.

I would have had to get my brother’s consent before doing that. If I did that on my own my brothers would have been very very upset with me. I just never had that conversation with them. [ 61 ] When shown the minutes recorded by Adams, Edgar Smith stated that he never made a statement that all debts would be written off and that the new company would have no debts (save for the bank). Nor did he agree that Mr. Adams’ debt would be repaid first. [ 62 ] I accept Edgar Smith’s evidence on these issues and prefer it to that of Mr. Adams.

It seems to me that if the plaintiffs truly believed the extraordinary stroke of luck relieving the Cheese Co. of a large debt, they would have had this agreement properly recorded. [ 63 ] The Plaintiffs’ claim is dismissed. Costs follow the event but the parties may speak to that issue if an agreement cannot be reached. “The Honourable Mr. Justice McKinnon”