- Weil Bankruptcy Blog - http://business-finance-restructuring.weil.com -

Is it Wrongful to Pay a Dividend While Facing Litigation? A Québec Court May Answer

NORTH OF THE BORDER UPDATE

This article has been contributed by Martin Desrosiers and Julien Morissette. Martin Desrosiers is a Partner in the Insolvency and Restructuring group of Osler, Hoskin & Harcourt LLP, and Julien Morissette is an Associate in the Group.

The Bankruptcy and Insolvency Act (BIA) provides that a dividend payment which renders a company insolvent, or which is made while a company is insolvent, is reviewable. The BIA extends liability to the company’s directors unless they can show diligence. While the company is solvent but facing substantial litigation, can it nonetheless be wrongful or tortious for directors to authorize payment of dividends? A Québec court may soon have to answer this question.

Domfer Metal Powders Holdings Ltd. (Domfer) was a scrap steel recycler operating on the Island of Montréal. Its main clients were car manufacturers in the U.S. In 1997, the Comité d’environnement de Ville-Émard (CEVE) filed a class action (the First Class Action) before the Superior Court of Québec. This organization represents a group of persons residing near the Domfer plant whom alleged having suffered from neighbourhood annoyances (nuisances) as a result of environmental damage linked to Domfer’s activities.

In 2002, the First Class Action was dismissed at trial. CEVE appealed. In early 2003, Domfer proceeded to a corporate reorganization, from which Kenneth G. Stodola and Gilles L’Espérance – sole directors and shareholders of Domfer (the Directors) – received about $14.2 million (the Dividend). In 2006, the Québec Court of Appeal granted CEVE’s appeal and ordered Domfer to pay the plaintiffs approximately $1.6 million. A further appeal by Domfer was discontinued. In early 2008, Domfer filed for bankruptcy, while the Court of Appeal’s award remained unpaid.

In 2009, CEVE settled with Domfer’s trustee in bankruptcy and insurance company for approximately $124,000 (the Settlement). Finally, in early 2011, CEVE filed a new class action against the Directors, alleging that they committed an extra-contractual fault in authorizing the Dividend in 2003. This new action seeks payment of about $1.5 million, i.e. the difference between the Settlement and the Court of Appeal’s award in the First Class Action. In a short judgment, Justice Perrault of the Superior Court of Québec authorized (certified) this new class action last year.

The parties debated whether or not the alleged facts seemed to justify the judgment sought on the merits. Justice Perrault’s ruling does not prejudge of the result on the merits, but it provides insight into uncharted issues that will need to be addressed unless a settlement occurs before the trial.

CEVE’s main allegations are that the Directors were careless and self-interested when they authorized the Dividend and that this Dividend substantially weakened Domfer’s financial position and ultimately caused the bankruptcy. As highlighted by the Court, several key issues of fact and law will need to be addressed:

In Québec, a judgment authorizing a class action cannot be appealed. Therefore, this matter will either settle or go to trial on the merits. By class action standards, the plaintiff group is small – CEVE represents about 500 individuals – as are the damages sought. However, the legal issues which would have to be resolved on the merits are far ranging and will be closely watched by insolvency litigators across Canada.

In Castor Holding Ltd. (Syndic de), 2008 QCCS 3437 (in French but head notes in English are available under reference 2008 Carswell Que 7246), a former director was ordered to pay $8.8 million to a trustee in bankruptcy for having authorized a dividend while the company was clearly insolvent (appeal dismissed by default sub nom. Castor Holdings Ltd. c. RSM Richter Inc., 2009 QCCA 829 ).
Comité d’environnement de Ville-Émard (CEVE) c. Stodola, 2012 QCCS 2550 (in French only).
Code of Civil Procedure, R.S.Q., c. C-25, article 1003(b) .
R.S.C. 1985, c. C-44 , sub-section 122(1)(b).
Code of Civil Procedure, R.S.Q., c. C-25, article 1010 .