EY Holdings Ltd., G&O Holdings (1973) Ltd., GEO Properties Inc., Stephana Holdings Ltd., Ernest Yakimovich v. Julianna Olga Yakimovich, 2017 BCSC 129

IN THE SUPREME COURT OF BRITISH COLUMBIA Citation: EY Holdings Ltd. v. Great Pacific Mortgage & Investments Ltd., 2017 BCSC 129 Date: 20170127 Docket: 15-1524 Registry: Victoria Between: EY Holdings Ltd., G&O Holdings

(1973) Ltd., GEO Properties Inc., Stephana Holdings Ltd., Ernest Yakimovich and Julianna Olga Yakimovich Plaintiffs And: Great Pacific Mortgage & Investments Ltd., Jeffery Alexander Moses, Walter Rodney Neufeld and Rory Howard Campbell Defendants Before: The Honourable Mr. Justice Bracken Reasons for Judgment Counsel for Plaintiffs: L. L. Bevan Counsel for Defendants: M. D. Adlem Place and Date of Hearing: Victoria, B.C. August 11, 2016 Place and Date of Judgment: Victoria, B.C. January 27, 2017 [ 1 ] The defendants apply pursuant to Rule 9-5(1)(

a) to strike out certain paragraphs of the plaintiffs’ Notice of Civil Claim. The basis for the application is that the paragraphs at issue violate the rule expressed in Foss v. Harbottle (1843), 2 Hare 461, 67 E.R. 189 (Ch) . [ 2 ] The plaintiffs are former shareholders in Accredit Mortgage Ltd. (“Accredit”), a mortgage investment corporation (“MIC”). Accredit engaged Great Pacific Mortgage & Investments Ltd. (“Great Pacific”) to manage its investments and related financial affairs as an MIC.

The directors and officers of Accredit and Great Pacific are the same and the plaintiffs say that as a result, the same people are the controlling minds of both companies. [ 3 ] Over a period of several years, the plaintiffs invested significant amounts of money through investments they made by purchasing shares in Accredit. Dividends paid to the plaintiffs by Accredit were reinvested in Accredit. The plaintiffs say that between 2005 and 2012, the value of Accredit’s mortgage portfolio grew from approximately $21 million to $58 million.

The various fees charged by Great Pacific for its services increased accordingly. [ 4 ] The plaintiffs say that they relied on Great Pacific to manage Accredit’s portfolio in a reasonable and responsible manner and to keep them informed of information relevant to Accredit’s investments. [ 5 ] In 2012, the plaintiffs say that they discovered that 88% of the loans in the Accredit portfolio were non- performing and at risk.

They say they also learned that Great Pacific and its directors were managing Accredit’s financial affairs in contravention of Accredit’s policies, the terms of its Offering Memoranda and Great Pacific’s own investment policy.

As a result, the plaintiffs say they lost more than $3.7 million dollars they had invested in Accredit. [ 6 ] The defendants submit that portions of the allegations in the Notice of Civil Claim are allegations of wrongs committed against Accredit and not the plaintiffs and those claims must be brought by Accredit or by way of a derivative action. [ 7 ] The Notice of Civil Claim also contains allegations of negligent misrepresentation and breach of fiduciary duty.

The defendants do not challenge the right of the plaintiffs respecting those allegations. [ 8 ] The plaintiffs say that MICs enjoy a special tax status that treats the corporation simply as a conduit for funds so that an investor is placed in the same position from a tax perspective as if the investment made by the corporation was made directly by the investor. [ 9 ] The plaintiffs say that it is not clear that the rule in Foss and Harbottle applies in the circumstances of this case given the

unique characteristics of an MIC. They say it is possible they may succeed in the claims that are challenged by the defendants. Background Facts [10] An MIC is a company which acquires investment funds through the sale of shares, and then pools the funds for the purpose oflending the funds to others, largely property developers.

The plaintiffs say that their investments are treated from an income taxperspective as if they had made an investment directly to Great Pacific. [11] That is because MICs enjoy a special tax status as a result of certain provisions in the Income Tax Act, which allowsshareholders of an MIC to avoid double-taxation. In order to retain its status as an MIC under the Income Tax Act, all of the net incomeof Accredit must be distributed through dividends issued to shareholders. [12] Accredit and its funds were, at all relevant times, managed by Great Pacific pursuant to a financial services agreement.

Pursuant to the terms of the financial services agreement, Accredit agreed to indemnify and save harmless Great Pacific and its directors,officers, and employees against all claims, costs and damages Great Pacific may suffer by virtue of, in connection with, or arising out of,the management of Accredit’ s portfolio. [13] As part of the financial services agreement between Accredit and Great Pacific, Accredit has agreed to indemnify and saveGreat Pacific its directors, officers and employees harmless from any loss or claim that Great Pacific may suffer as a result of itsrelationship with Accredit.

Thus, it appears that all profits due to Accredit must be directly passed to and taxed in the hands of theshareholder investors, and any loss Great Pacific suffers is passed to Accredit and in turn to the investors. [14] The investors in Accredit cannot sell shares to outside investors.

When an investor wished to withdraw their capital from theMIC, the corporation bought back those shares at a price based on the net asset value of the portfolio in accordance with the thenexisting redemption of shares policy of Accredit. [15] The plaintiffs say that Accredit revised its redemption of shares policy from the original offer of $1.00 per share, then furtheramended its redemption policy to lower the redemption price to $0.75 per share, and then finally reduced the redemption amount to$0.50 per share.

The plaintiff says that the reduction of the assets of Accredit and the devaluation of its shares were simply passed on tothe investors. [16] The plaintiffs also plead that due to the mismanagement by and misrepresentations of Great Pacific, the plaintiffs were forced tocrystallize their losses by selling shares they had purchased $1.00 per share back to Accredit for price of $0.50 per share and as a resultthey suffered a significant loss of their investment. [17] The plaintiffs say due to the unique nature of an MIC, the rule in Foss v. Harbottle should not apply.

They submit that an MICis simply a corporate conduit for profit and loss that passes directly to the investors. They also point out that the individual defendantsare the controlling mind of Accredit and there is no likelihood that Accredit will commence an action against any of the defendants, andthere is no risk of a multiplicity of actions. The plaintiffs say that the facts in this case are novel and in the circumstances they should begiven the opportunity to fully develop their case at trial. Application to Strike [18] The test to strike pleadings is found under R. 9-5(1) of the Supreme Court Civil Rules.

The rule reads as follows: Scandalous, frivolous or vexatious matters

(1) At any stage of a proceeding, the court may order to be struck out or amended the whole or any part of a pleading, petition orother document on the ground that (

a) it discloses no reasonable claim or defence, as the case may be … [19] In Hunt v. Carey Canada Inc., (SCC), [1990] 2 S.C.R. 959 at para. 33, the test governing R. 9-5(1)(

a) is asfollows: … [A]ssuming that the facts as stated in the statement of claim can be proved, is it “plain and obvious” that the plaintiff's statement ofclaim discloses no reasonable cause of action? … [I]f there is a chance that the plaintiff might succeed, then the plaintiff should not be“driven from the judgment seat”. Neither the length and complexity of the issues, the novelty of the cause of action, nor the potential forthe defendant to present a strong defence should prevent the plaintiff from proceeding with his or her case.

Only if the action is certain tofail because it contains a radical defect … should the relevant portions of a plaintiff's statement of claim be struck out under Rule [9-5(1)(a)]. [20] In Knight v. Imperial Tobacco, 2011 SCC 42 at para. 21, the Supreme Court of Canada restated the test as “whether, assumingthe facts pleaded are true, there is a reasonable prospect that the claim will succeed.” Rule in Foss v. Harbottle [21] The rule in Foss v. Harbottle provides simply that a shareholder of a corporation does not have a personal cause of action for awrong done to the corporation.

A shareholder cannot be sued for the liabilities of the corporation and, equally, a shareholder cannot suefor the losses suffered by the corporation. If an action is to be brought in respect of such losses, it must be brought either by thecorporation itself or by way of a derivative action [22] The rationale for the rule was discussed in Hercules Management Ltd. v. Ernst & Young, (SCC), [1997] 2

S.C.R. 165, 1997 CarswellMan 198 (WL), at para. 59: [59] The rule in Foss v. Harbottle provides that individual shareholders have no cause of action in law for any wrongs done to thecorporation and that if an action is to be brought in respect of such losses, it must be brought either by the corporation itself (throughmanagement) or by way of a derivative action. The legal rationale behind the rule was eloquently set out by the English Court of Appealin Prudential Assurance Co. v. Newman Industries Ltd.(No. 2), [1982] 1 All E.R. 354 [Eng. C.A.], at p. 367, as follows: The rule [in Foss v.

Harbottle] is the consequence of the fact that a corporation is a separate legal entity. Other consequences arelimited liability and limited rights. The company is liable for its contracts and torts; the shareholder has no such liability. The companyacquires causes of action for breaches of contract and for torts which damage the company. No cause of action vests in the shareholder.

When the shareholder acquires a share he accepts the fact that the value of his investment follows the fortunes of the company and thathe can only exercise his influence over the fortunes of the company by the exercise of his voting rights in general meeting. The lawconfers on him the right to ensure that the company observes the limitations of its memorandum of association and the right to ensurethat other shareholders observe the rule, imposed on them by the articles of association.

If it is right that the law has conferred or shouldin certain restricted circumstances confer further rights on a shareholder the scope and consequences of such further rights require carefulconsideration. To these lucid comments, I would respectfully add that the rule is also sound from a policy perspective, inasmuch as it avoids theprocedural hassle of a multiplicity of actions. Escaping the Rule in Foss v.

Harbottle [23] Normally, in order for a plaintiff shareholder to bring a claim “the plaintiff shareholder must show not only an independentrelationship or duty exists between the shareholder and the wrongdoer, but also that the plaintiff has suffered a loss separate from that ofthe company that is causally linked to the personal wrong done to the plaintiff”: Robak Industries Ltd. v. Gardner, 2007 BCCA 61.

Inthat case, the court said at para. 21: [21] The appellants argue that in Hercules, the Supreme Court left the door open to actions by shareholders, even where thecorporation may also have a separate and distinct cause of action. Justice LaForest wrote (at para. 62): One final point should be made here. Referring to the case of Goldex Mines Ltd. v.

Revill (1974), (ON CA), 7 O.R.(2d) 216 (C.A.), the appellants submit that where a shareholder has been directly and individually harmed, that shareholder may have apersonal cause of action even though the corporation may also have a separate and distinct cause of action. Nothing in the foregoingparagraphs should be understood to detract from this principle.

In finding that claims in respect of losses stemming from an allegedinability to oversee or supervise management are really derivative and not personal in nature, I have found only that shareholders cannotraise individual claims in respect of a wrong done to the corporation. Indeed, this is the limit of the rule in Foss v. Harbottle.

Where,however, a separate and distinct claim (say, in tort) can be raised with respect to a wrong done to a shareholder qua individual, a personalaction may well lie, assuming that all the requisite elements of a cause of action can be made out. [24] The Court of Appeal summarized the reasons for not allowing a shareholder to claim the loss of value of its shares at paras. 35 -37 of its decision. The Court noted that the rule avoids a multiplicity of actions, but also that any loss suffered by a corporation is a lossto all of the shareholders not just some of them.

The court also noted that while double recovery is avoided by applying the rule in Fossand Harbottle, it is not necessarily the principal reason. The court said at para. 37 that the rule “…bars recovery by one or some of theshareholders at the expense of creditors and other shareholders of the company.” Discussion [25] While the rule in Foss v.

Harbottle may well apply in the circumstances of this case, given the nature and purpose of MICs, andthe relationship between Accredit and Great Pacific, the plaintiffs say that they should be allowed to proceed to a full trial where all ofthe evidence respecting the legal relationship between the investors and Accredit and Great Pacific can be presented. The plaintiffsargue that all of the evidence should be considered by a court before deciding whether the rule in Foss v. Harbottle should apply in thecircumstances of this case.

Nature of the Loss [26] The law seeks to avoid a shareholder making a claim for a loss that is properly the loss the corporation.

Where a loss is merelyderivative of a loss to a corporation, the corporation must bring an action in respect of the loss or the shareholders should seek leave tocommence a derivative action. [27] However, due to the nature and ostensible purpose of an MIC, it can be argued that an MIC is incapable of truly suffering anactionable loss. [28] In order to remain compliant with the Income Tax Act, the net investment income earned by the MIC flows through to theinvestor/shareholders through dividends.

Thus, an MIC does not retain any profit regardless of the size of the investment funds. [29] Likewise, if an MIC, suffered a “loss” caused by a third party that reduces its investment portfolio, such a “loss” will have noappreciable impact on the MIC in terms of profitability given that an MIC is entirely indifferent to the loss because it is able to simplyissue a revised redemption of share policy that reflects a lower per share value and thus passes the loss directly to the shareholders. [30] On the facts of this case, the pleadings allege that Accredit evaluated its net asset value as being lower than the sum total of itsobligations to shareholders and accordingly, issued revised share redemption prices to adjust for the loss.

The result was that Accreditwas no longer obliged to repurchase shares at $1.00 per share, but was unilaterally able to adjust for the loss of net asset value so that itwas only obliged to repurchase shares at $0.75 per share and then ultimately at only $0.50 per share.

[ 31 ] As an MIC passes on all net income to its shareholders through dividends, it is arguable that in the same way, an MIC passes on all losses to its shareholders through revised share redemption prices. Even if the shareholder chooses not to execute that revised repurchase agreement, Accredit may be able to eliminate its liability to shareholders to reflect the current net asset value of its portfolio. [ 32 ] It is thus arguable that the loss immediately becomes the loss of the shareholders as a class.

Although the loss may increase or decrease upon subsequent reissuing of the share redemption policy, it is arguable that the loss will only crystallize once a shareholder executes the agreement and sells the shares back to the MIC at a loss. [ 33 ] Here, the plaintiffs say that they have suffered a loss but Accredit has not. They argue that as the profits and losses of Accredit must be passed on to the shareholders or investors, Accredit has no loss to claim. Therefore, the plaintiffs are the only ones able to advance claims against the defendants.

Whether that argument has merit remains to be seen, but without a full examination of all of the facts and agreements between the investors and Accredit, and Accredit and Great Pacific, I am not able to say that it is “plain and obvious” the plaintiffs claim cannot succeed. [ 34 ] If Accredit has not truly suffered an actionable loss, or that based on its unique purpose and structure Accredit is disinterested in ever bringing an action for the loss alleged in this matter and if the plaintiffs are barred from bringing an action themselves, Great Pacific could be immunized from any action resulting from the alleged mismanagement of Accredit’s funds.

This is even more likely given that Accredit and Great Pacific share the same directors and given that Accredit has agreed to indemnify Great Pacific. Multiplicity of Proceedings [ 35 ] The rule in Foss v. Harbottle aims in part to avoid the undesirable situation of a multiplicity of proceedings. However, on the facts of this case, that concern may not have much merit. [ 36 ] Again, I am not proposing a new categorical exception to the rule in Foss v. Harbottle for MICs.

Rather, on the facts of this case alone, it is uncertain whether allowing this action to proceed to a full trial on the existing pleadings would give rise to a multiplicity in proceedings. [ 37 ] At this stage of the proceedings, there does not appear to be evidence which would suggest that the risk of a multiplicity of proceedings is such that the plaintiffs should be barred from proceeding. Conclusion [ 38 ] I am not able to find at this stage of the proceedings that the plaintiffs’ claim does not have a reasonable prospect of success.

While the defendants may be successful in the end, it is my view that this action should be allowed to proceed to trial with the benefit of an opportunity for the plaintiffs to present all of the available evidence. [ 39 ] Therefore, the application of the defendants is dismissed. Costs will be in the cause. “J. K. Bracken, J.” The Honourable Mr. Justice Bracken