2012 ONSC 1820, 2012 ONSC 1820

Swinkels v. American Home Assurance Company Swinkels v. I.I.G. International Investment Group Inc. et al. [Indexed as: Swinkels v. American Home Assurance Co.] 110 O.R. (3d) 288 2012 ONSC 1820 Ontario Superior Court of Justice, Divisional Court, Hackland R.S.J., Pierce R.S.J. and Matlow J.

April 10, 2012 Corporations -- Derivative actions -- Complainant -- Company acting as escrow trustee with respect to investment made by plaintiff -- Plaintiff bringing action against company and its principal and controlling [page289] mind alleging that because of their actions her investment was not secured -- Plaintiff also suing insurer for indemnification pursuant to fidelity bond issued to company -- Plaintiff subsequently applying successfully to amend statement of claim to add derivative claim against insurer on behalf of company under s. 246(1) of Business Corporations Act -- Company's appeal allowed -- Motion judge erring in finding that plaintiff was proper complainant -- Proposed derivative claim falling outside scope of coverage provided by bond as principal was not employee of company and it would have been impossible for principal to act dishonestly or fraudulently in relation to company which was his alter ego -- Business Corporations Act, R.S.O. 1990, c.

B.16, s. 246(1). The plaintiff made an investment with IIG by way of a debenture. PCC was to act as escrow trustee. The plaintiff subsequently sued IIG, PCC, its principal, B, and others, claiming repayment of her investment. She alleged that, because of certain actions taken by PCC and B, her investment was not secured as required, that she was unable to recover any part of her investment and that there was no prospect of repayment by IIG. She brought a second action against AHIC, claiming indemnification pursuant to a fidelity bond which it issued insuring PCC against certain types of losses.

The plaintiff moved successfully to add a derivative claim pursuant to s. 246(1) of the Business Corporations Act against AHIC in the name of PCC. PCC and B appealed. Held, the appeal should be allowed. The motion judge erred in finding that the plaintiff was a complainant within the meaning of s. 245 (

c) of the Act . In order for the plaintiff's proposed derivative claim to fall within the scope of the coverage provided by the fidelity bond, she would have to prove that B was an employee of PCC; B, as an employee, committed a dishonest or fraudulent act; B's acts directly caused PCC to suffer a loss; B had a clear or obvious intent to cause PCC to suffer the loss and to obtain a financial benefit for himself; and B received a financial benefit as a result of his acts.

Throughout her amended statement of claim, the plaintiff identified the conduct of B with that of PCC and alleged that both B and PC committed dishonest and fraudulent acts in relation to her, but not in relation to PCC itself. B was PCC's sole officer and director. There was no evidence that he was an employee of PCC. He was the controlling mind of PCC. It would have been impossible for B to act dishonestly or fraudulently in relation to PCC, his alter ego, because it is fundamental that one cannot deceive or defraud oneself.

The proposed derivative claim fell outside the scope of the coverage provided by the bond. Although the plaintiff suffered a loss, PCC did not. Nor would a judgment against PCC in favour of the plaintiff at some time in the future constitute a "loss" to PCC as required by the fidelity bond. The plaintiff's intended action was bound to fail. APPEAL from an order granting leave to the plaintiff to amend a statement of claim. [page290] Cases referred toSwinkels v. American Home Assurance Co. (October 26, 2010), Campbell J. (S.C.J.) Statutes referred to Business Corporations Act, R.S.O. 1990, c.

B.16, ss. 245 , (c), 246 , [as am.], (1), (2)(c), 255 David J. Kirwin, for plaintiff (respondent). No appearance for American Home Assurance Company. Philip A. Garbut, for defendants (appellants).

The judgment of the court was delivered by MATLOW J.: -- The Order in Appeal [ 1 ] This is an appeal by two of the defendants in the second of the above-titled actions from the order of Justice Campbell dated October 26, 2010, made in the first of the above-titled actions, granting leave to the plaintiff in both actions ("Swinkels"), to amend her statement of claim in accordance with a draft amended statement of claim that is attached to the order.

The order permits her, as she requested, to add, to her direct claims against American Home Insurance Company ("AHIC"), derivative claims on behalf of and in the name of PCC First Capital Corporation ("PCC") and directs that the actions be tried "one immediately after the other". The Disposition [ 2 ] This appeal is allowed. The order in appeal is set aside and, in its place, an order is to issue dismissing the motion before the motion judge. The Background of this Litigation [ 3 ] In April 2001, Swinkels made an investment of US$450,000 with I.I.G. International Investment Group ("I.I.G.") by way of a debenture.

She now alleges that, because of certain subsequent actions taken by PCC, which was to act as escrow trustee, and its

principal, J. Bruce Baldock ("Baldock"), her investment was not secured as required and she has been unable to recover any part of her investment and there is no prospect of repayment of her investment by I.I.G. [ 4 ] In her efforts to obtain redress, Swinkels commenced two actions. The first action in time, Court File No. 50759 (the "I.I.G. action"), was commenced on June 19, 2006 against I.I.G., PCC, Baldock and others from whom Swinkels claims repayment of her investment and interest.

The second action in time, Court File No. 58575 (the "AHIC action"), was commenced on June 13, 2008 against American Home Assurance Company ("AHIC") from which she claims indemnification pursuant to a fidelity bond which it issued insuring PCC against certain types of losses. [page291] [ 5 ] Swinkels subsequently brought a motion in the AHIC action, but titled in both actions, seeking leave to amend her statement of claim in that action to add a derivative claim pursuant to s. 246(1) of the Business Corporations Act, R.S.O. 1990, c. B.16 (the "Act") against AHIC in the name of PCC.

By the order in appeal, she was granted that relief. [ 6 ] The combined prayer for relief set out in the draft amended statement of claim includes claims for the following relief: (

a) a declaration that the fidelity bond issued by AHI to PCC was in force at the relevant time; (

b) a declaration that AHIC is bound to indemnify her for "any and all damages proven against" PCC; (

c) a declaration that AHIC is bound to indemnify PCC "for all damages proven against PCC" in Action 50759; (

d) a money judgment against AHIC for $450,000 plus interest. The Issues [ 7 ] The issues in this appeal can best be understood by referring to the definition of "complainant" set out in s. 245 and s. 246 of the Act the statutory provision pursuant to which the order in appeal was made, which read as follows:

Definitions 245. In this Part, "action" means an action under this Act ; "complainant" means, (

a) a registered holder or beneficial owner, and a former registered holder or beneficial owner, of a security of a corporation or any of its affiliates, (

b) a director or an officer or a former director or officer of a corporation or of any of its affiliates, (

c) any other person who, in the discretion of the court, is a proper person to make an application under this Part. Derivative actions 246(1) Subject to subsection (2), a complainant may apply to the court for leave to bring an action in the name and on behalf of a corporation or any of its subsidiaries, or intervene in an action to which any such body corporate is a party, for the purpose of prosecuting, defending or discontinuing the action on behalf of the body corporate. [page292] Idem

(2) No action may be brought and no intervention in an action may be made under subsection (1) unless the complainant has given fourteen days' notice to the directors of the corporation or its subsidiary of the complainant's intention to apply to the court under subsection (1) and the court is satisfied that, (

a) the directors of the corporation or its subsidiary will not bring, diligently prosecute or defend or discontinue the action; (

b) the complainant is acting in good faith; and (

c) it appears to be in the interests of the corporation or its subsidiary that the action be brought, prosecuted, defended or discontinued. Notice not required

(2.1) A complainant is not required to give the notice referred to in subsection (2) if all of the directors of the corporation or its subsidiary are defendants in the action. Application

(3) Where a complainant on an application made without notice can establish to the satisfaction of the court that it is not expedient to give notice as required under subsection (2), the court may make such interim order as it thinks fit pending the complainant giving notice as required. Interim order

(4) Where a complainant on an application can establish to the satisfaction of the court that an interim order for relief should be made, the court may make such order as it thinks fit. @7 . . . . . Appeal 255. An appeal lies to the Divisional Court from any order made by the court under this Act . [ 8 ] Leave was granted to the appellants to appeal on two issues, described in the order granting leave as follows: (

a) whether the plaintiff is entitled to bring the application for leave to commence a derivative action by way of a motion to amend her statement of claim; and (

b) whether the plaintiff is a proper complainant within the meaning of the Business Corporations Act (Ontario) . [ 9 ] I observe, however, that it was not necessary for the appellants to seek leave to appeal as s. 255 of the Act provides an unrestricted right of appeal. [page293] Analysis

[10] For the reasons that follow, I would prefer to confine my determination of this appeal to the issue referred to in para. 7(

b) above.Although counsel for the appellants did not explicitly abandon his reliance on the prior issue, his submissions made it clear that heviewed the second as the major determining issue and we agreed. [11] It is useful to begin the analysis of this appeal by recognizing once more that the order in appeal would permit Swinkels to prosecutederivative claims in the name and on behalf of a corporation which, in this case, is PCC.

Accordingly, it is necessary to begin byseparating the claims which she would assert on behalf of PCC, which does have privity with AHIC as the party insured by the fidelitybond, from her original personal claims against AHIC, with which she does not have privity. [12] Paragraphs 19 to 25, inclusive, of the amended statement of claim contains Swinkels' allegations against PCC and Baldock. They areas follows: Dishonest and Fraudulent Act by Employees of PCC 19. As noted above, PCC, through Bruce Baldock, opened up bank accounts at two financial institutions, the Royal Bank of Canada andWells Fargo Bank.

Both accounts required a signature from Baldock on behalf of PCC and Stephen Hawkins of IIG. 20. The Plaintiff's investment funds were deposited into one or both of these accounts. 21. PCC, as the escrow trustee, had an obligation to ensure that the Plaintiff's monies were deposited into secured investments of GradeA quality or higher. 22. Contrary to this obligation, the Plaintiff's investment funds were then transferred to an individual or individuals without the benefit ofany security whatsoever as contemplated by the terms of the Subscription Agreement and Debenture. 23.

PCC's employee Baldock facilitated this transfer by providing Stephen Hawkins with executed, blank transfer forms permittingStephen Hawkins to transfer whatever sum he wished to whatever entity he wished without the benefit of a review by the trustee PCC. 24. In so doing, the Plaintiffs (sic) state that the employee of PCC, Baldock breached his fiduciary obligations to PCC and waseffectively dishonest and fraudulent through his complete abdication of his responsibilities as a co-signer and escrow trustee on the bankaccounts into which the Plaintiff's monies were deposited. 25.

Accordingly, the Plaintiffs (sic) states that the Defendant has an obligation to indemnify PCC for the losses sustained by it as a resultof its employee, Bruce Baldock's, dishonesty and fraudulent conduct. [page294] [13] Paragraphs 21 and 27 to 31, inclusive, of the motion judge's endorsement include his views on the issues in this appeal. They read asfollows: 21. For the reasons that will follow, I find that the plaintiff in this action is a complainant within the meaning of s. 245(

c) of the Act.Further, the requirements of s. 246(2) have been met. Therefore, the plaintiff will be granted leave to amend the Statement of Claim asrequested. @7 . . . . . 27. Similarly, I believe that the third requirement as (sic) has been met. As stated by the Court in Richardson Greenshields of Canada Ltd.v. Kalmacoff, (ON CA), 18 B.L.R. (2d) 197, the requirement is only that the action appears to be in the best interestsof the corporation. Further, I am satisfied there is a reasonable basis for the complaint and the action sought to be instituted is at least alegitimate arguable one.

While I cannot be expected to try the case, I do not find the action is frivolous or vexatious or bound to beunsuccessful. (Marc-Jay Investments v Levy (1974), O.R. (2d) 235. 28. PCC and Baldock argue that this case is bound to fail for two reasons. First, the preconditions of the policy have not been met, andsecondly, that the limitation period has passed. In my view, the issue of the limitation period and the discoverability of the action is amatter for a trial judge and therefore I cannot say the action is bound to fail for that reason. 29.

With respect to the issue of the preconditions, I would comment as follows: (

i) The case as constituted establishes the loss was caused by employee (sic) of PCC, Baldock. Granted he now argues that he was actingin the capacity of I.I.G. but again a determination of that issue is for trial. (ii) Secondly, I find that PCC may suffer a loss. That is, a judgment against it by the plaintiff would be a loss. It is not determinative thatit does not have assets to cover such a loss. (iii) Thirdly, the loss must result from a fraudulent or dishonest act on the part of an employee. The allegation is that Baldock's actionswere fraudulent or dishonest.

On the basis of the admitted facts, his actions were at least extraordinarily careless. This coupled with thefact that Baldock was closely associated with I.I.G. may cause a court to find that his conduct falls within the requirements of the bondof indemnity. (iv) Fourthly, the loss must have resulted from a dishonest act of an employee intending to gain some financial benefit. The debenturegiven to Baldock without consideration, whether it was for profit sharing or some potential tax benefit, it is clearly of benefit to him. 30.

The defendant also argued that for policy reasons the court should not allow an action to reimburse an investor for loss. It is clearthat is not the basis of this claim. If that were the basis of the claim, it would not be legitimate and it would have no chance of success. 31. I do not agree that the derivative action is premature.

In my view, to wait for the determination of the factual issues before grantingleave would be an unnecessarily duplicitous (sic) and present the possibility of inconsistent verdicts. [page295] [14] The fidelity bond issued by AHIC to PCC contains provisions relevant to Swinkels' proposed derivative claim. The only coverage

conceivably responsive to such as claim is set out at p. 1 of the bond under the headings "INSURANCE AGREEMENT" and "FIDELITY". Paragraph (A), describing the coverage, reads as follows: Loss resulting directly from dishonest or fraudulent act committed by an Employee acting alone or in collusion with others. Such dishonest or fraudulent acts must be committed by the Employee with the manifest intent: (

a) to cause the insured to sustain such loss, and (

b) to obtain financial benefit for the Employee and which, in fact, result in obtaining such benefit. As used in this Insuring Agreement, financial benefit does not include any employee benefits earned in the normal course of employment, including salaries, commissions, fees, bonuses, promotions, awards, profit sharing or pensions. [ 15 ] It follows that, in order for Swinkels' proposed derivative claim to fall within the scope of the coverage provided by the bond, she would have to prove that (

a) Baldock was an employee of PCC; (

b) Baldock, as an employee, committed a dishonest or fraudulent act; (

c) Baldock's acts directly caused PCC to suffer a loss; (

d) when Baldock committed the acts, he had a clear or obvious intent to cause PCC to suffer the loss and to obtain a financial benefit for himself; and (

e) Baldock received a financial benefit as a result of his acts. [ 16 ] Throughout the amended statement of claim, Swinkels identifies the conduct of Baldock with that of PCC and, in essence, alleges that both Baldock and PCC committed "dishonest and fraudulent acts" in relation to her, the alleged victim, but not in relation to PCC itself. Both the appellants and Swinkels agree that, at all material times, Baldock was the sole officer and director of PCC and Baldock's evidence is that all of the shares of PCC were owned either by him or a family corporation.

According to Baldock's evidence, he did not act as an employee of PCC in relation to the subject transaction. Nor is [page296] there any evidence in the record before us that he was an employee of PCC at the relevant time. [ 17 ] As well, Swinkels recognizes that Baldock was the controlling mind of PCC, that his actions were the actions of PCC and that his knowledge of what occurred was the knowledge of PCC.

Indeed, on the record before us, PCC could not act or have any knowledge about anything except what Baldock did and what Baldock knew. [ 18 ] It follows, both as a matter of logic and a matter of law, that, in the circumstances of this case, it would have been impossible for Baldock to act dishonestly or fraudulently in relation to PCC, his corporation and his alter ego, because it is fundamental that one cannot deceive or defraud oneself.

This, alone, would bring the proposed derivative claim outside the scope of the coverage provided by the bond. [ 19 ] If Swinkels' proposed derivative action were allowed to proceed as proposed by her, it would follow that, having defrauded Swinkels, PCC would be allowed to seek to recover a sum of money from AHIC that PCC could hold to indemnify itself against any potential judgment that Swinkels might obtain against it.

It would be tantamount to a situation in which a fraudster seeks to recover on a fidelity bond to provide protection for himself against the contingency that his own victim might one day obtain redress in a court. To view the situation in this light shows the absurdity of the result and demonstrates why no insurer would provide such coverage and why any such claim would be bound to fail. [ 20 ] Although there can be no doubt that Swinkels did suffer a loss, PCC clearly has not. If anyone was deceived or defrauded by Baldock, it was Swinkels.

Nor would a judgment against PCC in favour of Swinkels at some time in the future constitute a "loss" to PCC as required by the fidelity bond. [ 21 ] Accordingly, with respect, I am persuaded that the motion judge could not have reasonably concluded, as he did, that Swinkels fell within the discretionary definition of complainant as a proper person set out in s. 245 (

c) of the Act . As shown above, Swinkels' intended action was clearly bound to fail and it was unreasonable for the motion judge to reach the opposite conclusion and conclude that it appears to be in the best interests of the corporation. [ 22 ] Although the order granting leave to appeal to this court expressly refused to grant leave to appeal on the issue of whether Swinkels "has satisfied the requirements established by s. 246(2) of" the Act , it is open to us to observe that the discretion created by s. 246(2) (

c) is intertwined with the discretion created [page297] by s. 245 (

c) and that it would create an absurdity to interpret the Act to hold that Swinkels, despite her intended action being bound to fail, could still be a proper person to bring the action and thereby qualify as a complainant. Indeed, s. 246 prohibits the bringing of a derivative action unless the requirement of it appears to be in the best interests is satisfied. The Standard of Review [ 23 ] I turn, finally, to the standard of review that is applicable in this appeal. As discussed in para. 13, above, the order in appeal was based on two essential preliminary findings that the motion judge was required to make, namely, whether Swinkels qualified as a complainant pursuant to s. 245 (

c) which depended on whether the it appears to be in the best interests requirement in s. 246(2) (

c) had been satisfied. Both findings made were in favour of Swinkels. Because both of these findings were left by the Act to be decided in the discretion of the motion judge, it follows, as a matter of logic, that the order in appeal should also be viewed as a discretionary order and for such orders the standard of review is that of reasonableness. [ 24 ] Applying that standard to the order in appeal, I would conclude that it is unreasonable for the following reasons, all of which are discussed above:

(1) The motion judge clearly misunderstood the coverage provided by the fidelity bond issued by AHIC and misapplied his

interpretation of it which was unreasonable; (2) the application of that

interpretation led the motion judge to make unreasonable preliminary findings in relation to ss. 245(

c) and 246(2)(c); (3) the application of the unreasonable preliminary findings led the motion judge to make the order in appeal which, in such circumstances, was inevitably unreasonable as well. Costs [ 25 ] Counsel may make written submissions to us with respect to costs, to be exchanged by them and delivered to the office of this court at London within 30 days of the release of these reasons.

Appeal allowed.