Sep 18, 2020

Shareholder actions for loss of share value: Are they now possible?

By Marco P. Falco
The Lawyer's Daily View original

At common law, a corporation has always been treated as a discrete legal entity from its shareholders. The rule in Foss v. Harbottle (1843), 67 E.R. 189 (U.K.H.L.) provides that only the corporation, not its shareholders, may start a lawsuit for wrongs done to it.

There are exceptions, such as “derivative actions.” But even in those cases, the shareholders commence the derivative action “on behalf of” the corporation. The lawsuit belongs to the company, not the shareholders.

But does a shareholder have a personal cause of action where harm is done to her personally as a result of a loss in company share value? Under an orthodox reading of Foss v. Harbottle, the answer is no.

But a recent decision of the Ontario Court of Appeal, Tran v. Bloorston Farms Ltd. 2020 ONCA 440, adopts an important exception to Foss v. Harbottle.

Bloorston Farms establishes that a shareholder can bring a claim for the diminution in share value to the company where only the shareholder, not the company, has a right to sue the defendant.

When a restaurant fails, who suffers the loss?

Bloorston Farms involved a commercial lease. The corporation, of which Sang Thi Tran was the sole shareholder, operated a restaurant on the premises. Tran was the only listed tenant on the lease.

In 2014, the defendant became Tran’s landlord when it purchased the building where the restaurant operated. Shortly thereafter, the landlord demanded increased payments of rent from the tenant. Tran disputed the changes to the restaurant’s rent and continued paying the rent she was already paying. The landlord ultimately terminated Tran’s tenancy and the corporation’s restaurant business ceased operating.

Tran started an action against the landlord for breach of the lease. The corporation was also a plaintiff to the action, even though it was not a party to the lease. Part of Tran’s claim involved an action for the loss of her share value as the sole shareholder of the corporation.

The landlord brought a motion for summary judgment, arguing that Tran, as a shareholder, could not personally claim the loss of the value of her shares when the corporation became worthless after the closure. The landlord relied on the rule from Foss v. Harbottle, arguing that only a corporation could bring an action for the harm done to it.

The motion judge rejected the landlord’s position.

The Superior Court held that there was an exception to the rule in Foss v. Harbottle where a company suffers a loss but has no cause of action to recover it. In that case, the shareholder can sue for the loss of share value.

Here, the corporation was not a tenant under the lease and therefore only Tran could bring an action for the diminution in share value. In the end, the motion judge awarded Tran damages of $140,614 for the loss of her share value.

The Ontario Court of Appeal upheld the motion judge’s ruling.

Exceptions to Foss v. Harbottle

The Court of Appeal began its analysis with a review of Foss v. Harbottle. As stated, this rule provides that a shareholder of a corporation does not have a personal right to sue for wrong done to the corporation: see Hercules Management Ltd. v. Young, [1997] 2 S.C.R. 165.

The policy underlying the rule in Foss v. Harbottle is as follows: (i) the corporation, as a discrete legal personality, is liable for the corporation’s acts, not its shareholders. Therefore, the company, not its shareholders, has the right to sue for wrongs done to it; and (ii) absent the rule, a shareholder would always be able to sue for wrongs done to the corporation which indirectly cause harm to the shareholder.

However, the Court of Appeal acknowledged that the rule has its limits. There are two important exceptions to Foss v. Harbottle:

  • Where both the shareholder and the company have separate and distinct causes of action against the defendant. This may occur, in the court’s view, where a shareholder and a corporation have causes of action against the director for misrepresenting the share value of the company;
  • Where only the shareholder has a cause of action for which the corporation can’t sue. This exception is known as the “Second Proposition” from Johnson v. Gore Wood & Co. [2001] B.C.C. 820 (U.K.H.L.). It is the exception adopted by the court in Bloorston Farms.

Here, the corporation has no cause of action whatsoever. Only the shareholder, Tran, has a cause of action. Since the rule in Foss v. Harbottle applies only to prevent a shareholder from suing for a wrong done to the corporation, the question is whether the rule has any application when the corporation has no cause of action and the shareholder, who does have a cause of action, makes a claim for diminution of share value.

This is the first of a two-part series.

This article was originally published by The Lawyer’s Daily, part of LexisNexis Canada Inc.