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Corporate Fraudulent Case: Midland Resources Holding Ltd. v. Shtaif

Corporate Fraudulent Case: Midland Resources Holding Ltd. v. Shtaif

**Midland Resources Holding Ltd. v. Shtaif, 2017 ONCA 320

Actions — Bars — Settlement — Plaintiff shareholders induced by defendants’ deceit and fraudulent misrepresentation to invest in sham company to develop oil and gas fields in Russia — Fraud coming to light in June 2006 — Parties entering into settlement agreement and reorganizing venture using new company — Plaintiffs suing defendants for fraudulent misrepresentation, deceit and conspiracy — Settlement agreement not precluding plaintiffs from asserting any claims for period before June 2006.

Corporations — Directors — Duties — Trial judge erring in finding that director was liable to shareholder for breach of director’s fiduciary duties to company.
Corporations — Shareholders — Plaintiff shareholders induced by defendants’ deceit and fraudulent misrepresentation to invest in sham company to develop oil and gas fields in Russia — Plaintiff’s claims against defendants for fraudulent misrepresentation and conspiracy not precluded by rule in Foss v. Harbottle — Plaintiffs suing in their own capacity as investors rather than as shareholders of sham company.

Torts — Fraudulent misrepresentation — Director of company liable for fraudulent misrepresentation based on his failure to disclose mate- rial facts at board meeting.


The plaintiffs AS and ES invested money in a corporation, Magellan, for the purpose of developing oil and gas fields in Russia. They advanced the funds through the plaintiff Midland Ltd. The venture was initiated by the defendant MS, an oil executive. Before the plaintiffs became involved, MS met IB, who was using a false name to hide his criminal past and represented himself to be a wealthy Toronto businessman. IB was the principal of BDW, a sham company. IB falsely represented to MS that BDW wanted to invest $70 million in MS’s oil field venture, and offered Magellan as the corporate vehicle for that venture, representing it as a Delaware public company trading on the Pink Sheets. In fact, Magellan was fraudulently created by IB specifically for MS’s venture. IB intended to target MS’s investors and use their participation in Magellan to lend it credibility, and to then unlawfully issue free trading shares at artificially inflated prices. There were many red flags that should have led MS to be wary of IB. The defendant EB, an investment advisor, arranged a meeting between AS, MS and himself. EB confirmed to AS that BDW was a sophisticated Bay Street investor. The plaintiffs agreed to invest $50 million in the proposed venture on the understanding that BDW had committed to investing $70 million. EB received a commission as a result. MS was aware that the $70 million would not be forthcoming. The defendant GR agreed to be BDW’s representative on Magellan’s board. At the first Magellan board meeting in January 2006, GR failed to disclose to the plaintiffs what he then knew: that IB was using a pseudonym to hide his criminal past, that BDW and Magellan were Pink Sheet companies that would not attract Canadian institutional interests, and that he had already received two million shares from IB without board approval. By June 2006, it had become apparent that Magellan was a sham company promoted by fraudsters. In order to keep the venture going, Midland Ltd. and Magellan entered into a settlement agreement which provided that the venture would be reorganized under a legitimate company, K Ltd. By mid-2007, the plaintiffs and the defendants had lost trust in each other. The plaintiffs sued and the defendants counterclaimed. The trial judge found for the plaintiffs and dismissed the counterclaims. The defendants appealed the judgment for the plaintiffs, and GR appealed the dismissal of his counterclaim.
Held, the appeal from judgment for the plaintiffs should be allowed in part; the appeal from the dismissal of the counterclaim should be dismissed.

The rule in Foss v. Harbottle did not preclude the plaintiffs from asserting their claims without seeking leave to commence a derivative action. The defendants had not specifically pleaded a Foss v. Harbottle defence, and had they done so it would have undercut the foundation for their own counterclaims. In any event, the plaintiffs were suing as investors and not as shareholders of Magellan. The rule in Foss v. Harbottle does not preclude a shareholder from maintaining a claim for harm done directly to it.

The defendants did not plead that the June 2006 settlement agreement operated to release the pre-June 2008 claims, nor did they raise the defence at trial. On that ground alone, it was not now open to them to assert the defence as a ground for setting aside the judgment. In any event, the personal plaintiffs were not parties to the settlement agreement and it contained no terms for their benefit, Midland Ltd. gave no release of claims in the agreement, and the agreement contained no provision purporting to release the defendants from claims unknown to the plaintiffs at the time the agreement was made.

The trial judge did not err in finding IB liable for fraudulent misrepresentation.

GR breached his fiduciary duties as a director by failing to disclose material information to the Magellan board at the first board meeting. However, the trial judge erred in awarding damages to Midland Ltd. for that breach. Midland Ltd. did not, as a shareholder, enjoy a cause of action against GR for his breach of fiduciary duty to Magellan. However, Midland could recover against GR for fraudulent misrepresentation. A misrepresentation can involve not only an overt statement of fact, but also certain kinds of silence. GR knew that the information he possessed about IB’s criminal past and name change was material, and he intended the plain- tiffs to rely on the favourable impression about BDW created by his silence. The plaintiffs acted to their detriment in relying on GR’s non-disclosure. Had the information been disclosed to the Magellan board, the board would not have proceeded with Magellan. Midland Ltd. suffered a direct loss as a result.

The trial judge did not err in finding MS liable to Midland Ltd. for deceit and unlawful conspiracy in respect of conduct that took place before June 21, 2006. She erred in finding MS liable to Midland Ltd. for his breach of fiduciary duty to Magellan, as Midland Ltd. was not the beneficiary of the duty and could not recover for its breach. However, that error had no effect on the judgment against MS for his pre-June 2006 conduct, given the trial judge’s findings against him of deceit.

The trial judge erred in finding liability against MS and GR based on post- June 2006 conduct.

The trial judge did not err in dismissing GR’s counterclaim.

Rule 25.07(4) of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194 requires a defendant to plead any matter on which he intends to rely to defeat the claim of the opposite party and which, if not specifically pleaded, “might take the opposite party by surprise or raise an issue that has not been raised in the opposite party’s pleading”. This requires a party to plead an affirmative defence, such as a plaintiff’s lack of standing to sue: Concord Kitchens GP Inc. v. Eastern Construction Co., [2010] O.J. No. 1597, 2010 ONSC 2168 (S.C.J.), at paras. 102-105; Huber v. Way, [2014] O.J. No. 3498, 2014 ONSC 4426 (S.C.J.), at paras. 66-68.

The reason for this pleading rule is quite simple. The just determination of a civil proceeding on its merits requires a fair adjudicative process. Trial by ambush is not fair. Accordingly, trial unfairness may result where a defendant is permitted to rely on an unpleaded defence which, if pleaded, might have prompted counsel to employ different tactics at trial: Strong v. Paquet Estate (2000), 50 O.R. (3d) 70, [2000] O.J. No. 2792 (C.A.), at para. 37, leave to appeal to S.C.C. refused [2000] S.C.C.A. No. 532. As this court stated in Hav-A-Kar Leasing Ltd. v. Vekselshtein, [2012] O.J. No. 5592, 2012 ONCA 826, at paras. 69-70:

The failure to raise substantive responses to a plaintiff’s claims until trial or, worse, until the close of trial, is contrary to the spirit and requirements of the Rules of Civil Procedure and the goal of fair contest that underlies those Rules. Such a failure also undermines the important principle that the par- ties to a civil lawsuit are entitled to have their differences resolved on the basis of the issues joined in the pleadings.

[W]here a defence to a civil action is not pleaded and no pleadings amendment is obtained, judges should generally resist the inclination to allow a defendant to raise and rely on the unpleaded defence if trial fairness and the avoidance of prejudice to the plaintiff are to be achieved.

The rule is not absolute. This court has excused defend- ants from their failure to raise an affirmative defence in the pleadings where the issue was otherwise clearly raised and put in issue before trial: Reliable Life Insurance Co. v. M.H. Ingle & Associates Insurance Brokers Ltd. (2002), 59 O.R. (3d) 1, [2002] O.J. No. 1382 (C.A.), at para. 36. However, raising a potentially dispositive issue during closing submissions, after the close of evidence, may well prove too late.

The rule in Foss v. Harbottle does not preclude a share- holder from maintaining a claim for harm done directly to it: Meditrust Healthcare Inc. v. Shoppers Drug Mart, a Division of Imasco Retail Inc. (2002), 61 O.R. (3d) 786, [2002] O.J. No. 3891 (C.A.), at para. 16. As this court stated in Goldex Mines Ltd. v. Revill (1974), 7 O.R. (2d) 216, [1974] O.J. No. 2245 (C.A.), at p. 221 O.R.: “Where a legal wrong is done to shareholders by directors or other shareholders, the injured shareholders suffer a personal wrong, and may seek redress for it in a personal action.” This principle was reiterated in Hercules Managements Ltd. v. Ernst & Young, where the Supreme Court stated, at para. 62:

[S]hareholders cannot raise individual claims in respect of a wrong done to the corporation . . . 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 personal action may well lie, assuming that all the requisite elements of a cause of action can be made out.

The Quebec Court of Appeal recently canvassed the issue of direct versus indirect harm in its decision in Groupe d’action d’investisseurs dans Biosyntech v. Tsang, [2016] Q.J. No. 17247, 2016 QCCA 1923, dismissing an appeal from the motion judge’s refusal to certify a class action brought by shareholders against directors of the corporation for loss in share value. In the course of considering whether the damages claimed by the shareholders were direct or indirect — the core issue in the case — the Quebec Court of Appeal observed, at para. 31:

Another example of direct damage suffered by a shareholder resulting from the acts of a director was described by the judge as the hypothetical case of the shareholder who purchases his shares based on the negligent or fraudulent misrepresentation of directors. Such a scenario causes the shareholder to have parted with his money to buy worthless shares and thus, suffers harm independent from the company giving rise to a good cause of action against directors for damages directly suffered by the shareholder.

Directors must serve the corporation selflessly, honestly, loyally and in good faith; they must avoid abusing their position to gain personal benefit: Peoples Department Stores Inc. (Trustee of) v. Wise, [2004] 3 S.C.R. 461, [2004] S.C.J. No. 64, 2004 SCC 68, at para. 35. These fiduciary duties flow from the trust and confidence shareholders repose in the directors to manage the corporation’s assets, including those transferred to the corporation by the shareholders: Peoples, at paras. 34-35.

As a result, a director owes a corporation a fiduciary duty to act honestly, which includes a duty to disclose material information: see, generally, Kevin P. McGuinness, Canadian Business Corporations Law, 2nd ed. (Markham, Ont.: LexisNexis, 2007), at §11.40; 484887 Alberta Inc. v. Faraci, [2002] A.J. No. 522, 2002 ABQB 406, 311 A.R. 355, at para. 28, citing Jackson v. Trimac Ltd., [1994] A.J. No. 445, 1994 ABCA 199, 20 Alta. L.R. (3d) 117, at p. 5 (QL).

Directors owe their fiduciary obligation to the corporation: Peoples, at para. 43; BCE, at para. 66. And, in BCE, the Supreme Court of Canada noted that “[n]ormally only the beneficiary of a fiduciary duty can enforce the duty”: para. 41. The court acknowledged this could work a harsh result because “[t]he directors who control the corporation are unlikely to bring an action against themselves for breach of their own fiduciary duty”: para. 41. However, in light of the availability of several other remedies to shareholders — such as the oppression remedy, a derivative action or an action based on a director ’s duty of care — the Supreme Court has resisted characterizing corporate stakeholders as the beneficiaries of directors’ statutory fiduciary duties: Peoples, at para. 53; BCE, at paras. 42-45.

That said, a director may owe an ad hoc fiduciary duty to a shareholder, especially in “situations involving a family or other close special relationships of trust and dependency between the claimant and the defendant director, in which the director was seeking to take advantage of that relationship for personal gain or profit”: Kevin McGuinness, Canadian Business Corporations Law, 2nd ed., at §11.194; Harris v. Leikin Group Inc., [2013] O.J. No. 1097, 2013 ONSC 1525 (S.C.J.), at paras. 401-402, affd (2014), 120 O.R. (3d) 508, [2014] O.J. No. 2914, 2014 ONCA 479.

Fraudulent misrepresentations

Fraudulent misrepresentation is established where there are the following five elements: (i) a false representation of fact by the defendant to the plaintiff; (ii) knowledge the representation was false, absence of belief in its truth, or recklessness as to its truth; (iii) an intention the plaintiff act in reliance on the representation; (iv) the plaintiff acts on the representation; and (v) the plaintiff suffers a loss in doing so: Amertek Inc. v. Canadian Commercial Corp. (2005), 76 O.R. (3d) 241, [2005] O.J. No. 2789 (C.A.), at para. 63, leave to appeal to S.C.C. refused [2005] S.C.C.A. No. 439.

A misrepresentation can involve not only an overt statement of fact, but also certain kinds of silence: the half-truth or representation that is practically false, not because of what is said, but because of what is left unsaid; or where the circumstances raise a duty on the representor to state certain matters, if they exist, and where the representee is entitled, as against the representor, to infer their non-existence from the represen- tor’s silence as to them: Robert Van Kessel and Paul Rand, The Law of Fraud in Canada (Toronto: LexisNexis, 2013), at §2.69 and 2.72.


The significance of silence always falls to be considered in the context in which it occurs: Demagogue Pty. Ltd. v. Ramen- sky (1992), 39 F.C.R. 31, 110 A.L.R. 608 (Aus. F.C.), at p. 32 F.C.R. As explained by Professor Waddams: “Almost always something is said to induce the transaction and it is open to the court to hold that the concealment of the material facts can, when taken with general statements, true in themselves but incomplete, turn those statements into misrepresentations”: S.M. Waddams, The Law of Contracts, 6th ed. (Aurora, Ont.: Canada Law Book Inc., 2010), at para. 439.

First, precision and particularity are necessary when pleading fraud. Rule 25.06(8) of the Rules of Civil Procedure requires any pleading of fraud or misrepresentation to contain “full particulars”. In Hamilton v. 1214125 Ontario Ltd., [2009] O.J. No. 3958, 2009 ONCA 684, 84 R.P.R. (4th) 25, this court identified, at para. 35, the necessary elements for a plea of deceit:

The pleading, even of innocent misrepresentation, must set out with careful particularity the elements of the misrepresentation relied upon, that is:
1. the alleged misrepresentation itself,
2. when, where, how, by whom and to whom it was made,
3. its falsity,
4. the inducement,
5. the intention that the plaintiff should rely upon it,
6. the alteration by the plaintiff of his or her position relying on the misrepresentation,
7. the resulting loss or damage to the plaintiff.
Of course, if deceit is alleged, then there must also be an allegation that the defendant knew of the falsity of his statement. . . . Each of the defendants must know the case that it has to meet.

**source: Ontario Reports

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