A shareholder of a corporation cannot sue for wrongs done to the corporation. This has been the law since the UK House of Lords decision Foss v. Harbottle in 1843. Since a corporation is a separate legal entity, only the corporation can bring actions for wrongs committed against it. The rule also prevents multiple actions being brought by shareholders, since they are always indirectly harmed when a wrong is done to a corporation.
However, a recent decision from the Ontario Court of Appeal shows that this rule may have some narrow exceptions.
In Tran v. Bloorston Farms Ltd., 2020 ONCA 440, the plaintiff was the sole shareholder of a restaurant who sued her commercial landlord for the diminution in the value of her shares. In 2010, she had entered into an agreement with the previous property owner, which specified the rent and square footage of the leased premises (the “Agreement”).
While the corporation that operated the restaurant was not a party to the Agreement, all parties knew that the restaurant would operate in the space. In 2014, the defendant landlord purchased the property and inherited the Agreement.
Shortly after it purchased the property, the landlord claimed the leased premises were larger than specified in the Agreement, and demanded increased rent for space and property taxes. The plaintiff refused to pay the increased rent and continued to act in accordance with the Agreement. The landlord then changed the locks on the leased premises and the restaurant business had to close.
The plaintiff sued the landlord for damages from breach of the lease, claiming the lost value of her shares as a result of the restaurant closing. The corporation that operated the restaurant was also a plaintiff to the action.
The motion judge held that the corporation had no cause of action against the landlord since it was not a party to the Agreement, but granted summary judgment in favour of the plaintiff, holding that the increased and additional rents were unjustified. As a result, the plaintiff won damages for the lost value of her shares in the corporation.
The landlord appealed, claiming primarily that the rule in Foss v. Harbottle bars the plaintiff’s claim for diminution in share value. The appeal was dismissed on the basis that Foss v. Harbottle rule did not apply in this situation. The Court held that the rule has limits, the two main ones being: (1) when both the shareholder and corporation have distinct causes of action; and (2) when the company suffers a loss but has no cause of action.
The first exception exists to ensure that shareholders are not deprived of independent, personal causes of action, but is carefully applied to ensure the personal action is not a disguised action for wrongs done to the corporation.
The second limit, which was applicable in this case, is where the corporation suffered a wrong but has no cause of action. Specifically, the corporation operating the restaurant was not a party to the Agreement but still suffered damages as a result of the breach. The Court also recognized that diminution of share value results from an independent relationship a shareholder has with a wrongdoer. While there is a corresponding loss to the corporation, a corporation cannot own its own shares and thus cannot claim for diminution in their value.
Applying this cause of action, the Court held that the loss of share value was a reasonably foreseeable consequence of the landlord breaching the Agreement and terminating the lease. The landlord knew the Agreement specified that the plaintiff would operate a restaurant, and the lost value of the shares is what would naturally and ordinarily be expected to occur from breaching the Agreement.
In the end, it was held that the landlord breached the lease and the plaintiff was awarded damages equal to her rent deposit and the lost value of her shares.
This decision shows that the rule in Foss v. Harbottle is still applicable and shareholders generally cannot sue for wrongs done to a corporation. However, there is an exception available where the company suffers a loss but does not have a cause of action itself.
Author: Daniel Waldman, Lawyer
The author would like to thank Ryan Deshpande, Summer Student-at-Law, for his assistance with this article.