'Just Friends' Or Something More? Court Finds Shareholders In Closely-Held Corporation Were Dealing At Arm's Length

In 1085372 Ontario Limited v. Kulawick, 2019 ONSC 2344, the Honourable Justice Penny dismissed an action to set aside a transaction under s. 96(1) of the Bankruptcy and Insolvency Act1 (the "BIA") as a transfer at undervalue or under s. 2 of the Fraudulent Conveyances Act2 (the "FCA") as a fraudulent conveyance. In its analysis, the court decided whether two shareholders were dealing at arm's length or not, and in so doing, relied on the leading case of the Alberta Court of Appeal in Piikani Nation v. Piikani Energy Corp, 2013 ABCA 293 ("Piikani"). Piikani has been cited approvingly by the Ontario Court of Appeal in Montor Business Corp. (Trustee of) v. Goldfinger, 2016 ONCA 406 ("Goldfinger"). Kulawick provides more comfort to clients in closely-held corporations that the court will not, simply by the nature of the parties' relationship, find that a transaction was non-arm's length.

The plaintiff was a creditor of Michael Shumak ("Shumak"), who had filed an assignment in bankruptcy on January 23, 2013. The trustee in bankruptcy originally commenced the action seeking relief under s. 96(1) of the BIA and s. 2 of the FCA, and this action was later assigned to the plaintiff. The defendant, Geoff Kulawick ("Kulawick"), was a shareholder of the other defendant, Linus Entertainment Inc. (the "Company"). Kulawick was also the President/CEO of the Company and ran it with full authority and control. Shumak was also a shareholder of the Company, having invested $1,000,000 in the Company in 2000, and had a shareholding interest equal to Kulawick's. There was also a third shareholder with a very small interest of 7% of the Company.

In 2010, Shumak (by then in financial trouble) sought to extract his investment back from the Company and between June 2010 and January 2011, received about $100,000 from Kulawick. These payments were not booked as dividends or return of capital, but Kulawick gave evidence that he considered them in substance a return of capital. Ultimately, the two agreed to an arrangement where Kulawick advanced a further $100,000, and an additional $150,000 to be paid over five years as "consulting fees". The documents (dated March 2011) to support this transaction included a letter agreement documenting the loan and security, a promissory note repayable on December 1, 2011, and a share pledge agreement. Although the initial $100,000 was advanced as contemplated, Shumak could not wait for the consulting fees and the parties agreed to an accelerated payment of the consulting fees at a discount. In that regard, $77,000 was paid to Shumak.

The loan came due on December 1, 2011. Shumak defaulted and on December 20, 2011, Kulawick foreclosed on Shumak's shares. The plaintiff challenged the transaction that led to Kulawick acquiring Shumak's shares for...