Nov 27, 2020

Why family separations can get messy when the major asset is a corporation

There is no sure path to enforce a personal debt against a corporation

By Laurie H. Pawlitza
Special to National Post View original

It is trite to say that in law, a corporation has its own rights and liabilities, and that the assets of the shareholder are not the assets of the corporation, nor are the corporation’s assets the shareholder’s assets. Among other things, of course, the existence of a corporation prevents a shareholder’s personal creditors from being able to realize their claims against the corporation’s assets.

What happens, then, when a couple separates and the reluctant payor spouse has one major asset: a corporation?

Earlier this year, the Alberta Court of Appeal wrestled with this issue in Aubin v. Petrone.

In 2018, the trial judge decided that Sabino Petrone owed Renee Aubin an equalization payment of $5.6 million. Petrone had no cash in his own name, and claimed he could not access any cash from Quantiam, the company in which he was the majority shareholder.

The facts of Aubin v. Petrone made this a difficult case. Quantiam was not owned by Petrone alone: He owned 84.7 per cent and Aubin owned four per cent, while 19 family members, friends and employees bought in as minority shareholders and held the remaining 11.3 per cent. A unanimous shareholder agreement governed the shareholders.

The relationship between Aubin and Petrone was quite traditional: Aubin looked after all matters of household management and childcare; Petrone made all the corporate decisions. Aubin left her outside employment and worked for the company, with her title, hours, salary and bonuses determined by Petrone. It appeared that, in part, Aubin’s employment was an income-splitting technique.

During the marriage, the couple bought a home in British Columbia, which was purchased by another company in which each held equal shares. Quantiam advanced the funds for the purchase and registered a mortgage on the property for the loan it made.

Both prior to and after separation, Petrone threatened that Aubin “would never see a single share from the company or a single dollar.” He also threatened to walk away from the company, liquidate it all and leave them both with nothing.

Shortly after separation, Petrone instructed Quantiam to demand payment of the loan against the B.C property, and then start foreclosure proceedings against it, in retaliation for Aubin starting her family law proceedings. Petrone also wrote to Quantiam’s corporate counsel to inquire about incorporating a new company to hold some of Quantiam’s assets in order to avoid matrimonial property division.

Petrone did not stop there. He terminated Aubin’s employment with Quantiam and removed her as a director of the company, replacing her with his best friend.

The trial judge found that when it came to Aubin, Petrone was “incapable of thinking clearly,” and that he was irrational to a troubling degree.

In dealing with the issue of security for the $5.6-million equalization payment, Petrone took the position that Quantiam needed to use all its assets as it saw fit. He also said that if there was an attempt to execute against Quantium on the property judgment, the company would be liquidated.

As a result, the trial judge decided to secure the money judgment against Petrone’s shares and ordered a charge against the building owned by Quantiam, in effect making Aubin a secured creditor of Quantiam.

In hearing Petrone’s appeal, the central issue for Alberta’s Court of Appeal was whether the trial judge had erred in law in piercing the corporate veil — especially given the 19 other shareholders of Quantiam.

On this issue, the court split, with Justices Peter Martin and Jolaine Antonio finding that the trial judge had not erred by piercing the corporate veil, and Justice Kevin Feehan dissenting on this issue.

The court first considered whether there was a separate, more relaxed threshold test for family law matters. It did not find a lower one, but indicated  there may be an “added factor” to consider, that being the recognition that “obligations imposed by family law are on equal footing with other legal obligations and deserve fair balancing where interests compete.”

In addition, the appellate court affirmed the trial judge’s observation that “in the family law context … the assets of the family unit are tied to the corporation.” The Court of Appeal also observed that in support matters, Child Support Guidelines specifically state the court may pierce the corporate veil when determining the income of a spouse who controls a corporation.

The corporate veil may be pierced if the claimant can meet a three-part test: the individual must exercise complete control of finances, policy and business practices; the control must have been used by him to commit a fraud or wrong that would unjustly deprive the other of a claim; and, the misconduct must be the reason for the claimant’s injury or loss.

What made this case particularly difficult was that Petrone was not the sole shareholder of the company. The majority of the court decided that while this was an important factor, it was not the only consideration in deciding whether to pierce the veil.

In addition to considering the other shareholders, the majority stated consideration had to be given to the nature of the company (private versus public), the reasonable expectations of the shareholders about how the company would be used by its principals, and whether the shareholders were bona fide purchasers for value.

Petrone argued, among other things, that he had not deprived Aubin of her rights (as he had not yet defaulted on the payment ordered). He also argued that ordering security was akin to transferring his shares to her. His final argument was that the trial judge erred by restraining him from taking any steps in bankruptcy until the security agreements were executed and registered.

The majority of the Court of Appeal made short work of Petrone’s arguments. In responding to his argument that a wrongdoing had not yet occurred since there had not yet been a default, the court said, “the point of the equalization payment is not to enrich Ms Aubin with Mr. Petrone’s money. It is to ensure that she regains what is already hers” … and, as such, this was “an unjust deprivation.”

The court also held that a charge on property does not depend on a transfer of ownership. Rather, a charge is “merely an incumbrance, a weight hanging on the asset which travels with it into the hands of third parties.”

Finally, the court held that the trial judge’s order temporarily enjoining bankruptcy was a “textbook” clause, as it mirrored the wording of a template order charging property, as set out in a well-known textbook on bankruptcy and family law.

Justice Feehan wrote a lengthy dissent on the issues, focusing on Quantiam’s other shareholders and that Petrone’s actions, while “aggressive and mean-spirited,” had not yet caused Aubin “to lose any part of the matrimonial property to which she was entitled.”

Unsurprisingly, Petrone sought leave to appeal to the Supreme Court of Canada. His application was dismissed.

The divided court in Aubin v. Petrone confirms that even in family litigation, there is no sure path to enforce a personal debt against a corporation.

This article originally appeared in the National Post.