In a recent split decision, a panel of the B.C. Court of Appeal (BCCA) considered the good faith and best interests requirements of the test for leave to commence a derivative action: 2538520 Ontario Ltd. v. Eastern Platinum Limited, 2020 BCCA 313.
A derivative action is a procedure pursuant to which a shareholder or other “complainant” may commence and control litigation in the name of a corporation that declined to commence its own litigation in respect of a wrong allegedly done to it. Derivative actions are most frequently brought by shareholders to redress alleged wrongs perpetrated by directors and officers against their own corporations, to the shareholders’ indirect prejudice. Leave (i.e. the court’s permission) is required to commence a derivative action.
While each provincial jurisdiction has its own legislation and body of jurisprudence, the test for leave to commence a derivative action is generally accepted as requiring the applicant to establish, at a minimum, good faith and that its proposed derivative action is in the corporation’s best interests.
The Applicant, 2538520 Ontario Limited (253), was a minority shareholder of Eastern Platinum Limited (EPL). 253 sought leave to commence a derivative action in the name of and on behalf of EPL against various past and present directors and officers of EPL, alleging breaches of fiduciary duty and negligence in authorizing EPL to enter a framework agreement and related transactions pertaining to the recovery and sale of chrome from tailings at a mine in South Africa.
The chambers judge dismissed 253’s leave application.
The Applicant appealed to the BCCA. The majority (Griffin and Bennett JJA) affirmed the decision of the chambers judge. Goepel JA dissented.
Good Faith Requirement
The majority explained that the onus to prove good faith in applying for leave to commence a derivative action is borne by the applicant. The respondent does not have to prove bad faith.
The majority agreed with the chambers judge, who described the burden of proving good faith as “substantial”. An applicant must prove its good faith with evidence that goes beyond bald assertions.
Further, the majority held that the chambers judge reasonably concluded that 253 had ulterior motives for applying for leave. 253’s ulterior motives were borne out by evidence of a past “proxy battle” pursuant to which 253 sought to gain control of EPL’s board of directors, 253’s own interest in purchasing chrome offtake from EPL, exaggerations in 253’s supporting affidavits, the limited notice given by 253 of its intention to pursue a derivative action, and the lack of any supporting evidence with regard to 253’s breach of fiduciary duty allegations.
While the merits of a proposed derivative action are a factor in assessing the good faith requirement, the majority concluded that the good faith requirement cannot be subsumed by an analysis of the merits. Hence, a lack of demonstrable good faith may justify the denial of leave, even if the applicant’s proposed derivative action is prima facie meritorious.
Best Interests Requirement
Under the best interests requirement of the test for leave, the majority explained that a court should consider the merits of the proposed derivative action and also determine whether the relief sought is outweighed by the resulting cost and inconvenience. The court may dismiss a leave application that technically satisfies the statutory requirements for leave if, overall, the evidence on the merits is thin.
The appellate majority found that the chambers judge failed to fully analyze the best interests requirement of the test for leave. In particular, the chambers judge erred in evaluating 253’s proposed negligence claim by only considering whether it was bound to fail, instead of considering whether it had a reasonable prospect of success, and by failing to consider whether the value of the potential relief would outweigh the inconvenience to EPL. 253 led no evidence to substantiate the merits of its proposed breach of fiduciary duty allegations.
The dissent reasoned that the best interests requirement is an overarching requirement and should therefore inform the good faith requirement of the test for leave to commence a derivative action.
The dissent stated, in part, that it was wrong to impose a “substantial” evidentiary burden beyond the balance of probabilities in relation to the good faith requirement. Further, an applicant’s “belief in the merits of a proposed claim, if accepted by the court” should be accepted as “a prima facie indication that the [applicant] is acting with proper motives.”
The dissent found that 253 had not acted improperly in seeking to acquire a majority of EPL’s shares in a “proxy battle” – and the chambers judge had erred in drawing a negative inference about 253’s motives as a result. From the dissent’s perspective, the evidence tended to prove that 253’s interest in pursuing a derivative action was to increase EPL’s share value, which was not improper.
The majority analysis from Eastern Platinum includes a helpful and thorough summary of the test for granting leave to commence a derivative action. The decision is particularly noteworthy in clarifying that leave to commence a derivative action may be denied, even if the proposed derivative action is presumptively meritorious, in the absence of “substantial” evidence of the applicant’s good faith. That is particularly the case if there is reason to suspect the applicant is driven to commence the derivative action by ulterior motives.